May 11, 2021

The Case for—and against—Eurobonds

When the EU reached agreement in 2020 on financing the European recovery fund by jointly borrowing on the financial markets, some spoke of a “Hamiltonian moment." It would indeed make sense to make eurobonds a permanent feature, argues the Greens’ Franziska Brantner, while Alexander Graf Lambsdorff from the pro-business Free Democrats (FDP) says they would split, not unite, the EU.

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A Question of Stability

Europe is in its deepest crisis since World War II. Yet there is a ray of hope: with its “Next Generation EU” recovery fund, the Recovery and Resilience Facility, the European Union has shown that it is capable of taking action in times of crisis. It’s a historic step: for the first time ever the EU member states are jointly borrowing on financial markets in order to address the economic consequences of the COVID-19 pandemic.

NGEU is clearly limited in time and scope. It totals €750 billion, and its loans must be paid back starting in 2027. The European Commission cannot issue further bonds unless new political agreements are reached. The question of the future of European fiscal policy remains, therefore, unanswered. However, there are four central arguments in favor of the principle of continued European borrowing.

First, the EU should not create a new emergency instrument for every European crisis. What we need is systemic change, away from short-term damage limitation and toward effective preparedness. This requires enshrining the principle behind the recovery fund in preparation for other emergency situations that affect all member states.

Second, it is not only in crises that the EU needs to be capable of taking financial action—it also needs these capabilities in order to finance the socio-ecological transformation of our European economy. Making Europe the first climate-neutral continent will require massive investment that goes much further than the recovery fund. Above all the EU needs its own revenues, for example from a carbon border adjustment mechanism, an expansion of the EU Emissions Trading System, and combatting tax evasion. But the joint issuance of bonds should also not be taboo as long as the EU can cheaply borrow on the markets and invest the money sensibly in the shared fight against climate change.

Third, eurobonds are not only an economic but also a foreign policy necessity. In the interest of an autonomous European foreign and security policy, the euro must be further developed into a global reserve currency. One prerequisite for this is the existence of a deep, liquid market of real, secure eurobonds. Having a strong euro would secure the EU’s sovereignty and ability to act, not only in the economic sphere but also in the political sphere.

Fourth, a powerful fiscal instrument would also make sense from a monetary policy perspective. It is now widely acknowledged that it is largely thanks to then European Central Bank (ECB) President Mario Draghi ("whatever it takes") that the EU was able to emerge from the financial crisis bruised but intact. At the beginning of the coronavirus crisis the EU was once again reliant on its central bank. Yet the ECB’s instruments are losing their edge, and there are political risks, as shown not least by the recent rulings by the German Constitutional Court. In the long run the ECB cannot be our only lifeline, neither for symmetrical shocks like the current pandemic nor for asymmetrical shocks. In the long run a common currency is not possible without common fiscal and economic policy—and that includes the ability to jointly incur debts.

We can no longer put off the question of how to design a stable, capable, sustainable European financial architecture. The next German government must lay the groundwork for this before work begins on the next Multi-Annual Financial Framework. – By Franziska Brantner


Creating Perverse Incentives

Eurobonds are the equivalent of Groundhog Day for the EU: for over 10 years now they have popped up again and again, only to disappear again before being dug up as a demand yet again the following year. There is an almost paradoxical political dynamic at work here. Left-wing parties in particular follow the logic of global financial markets, which desire such an instrument. It is all too appealing: the world's largest internal market issues bonds that are highly secure because, in the long run, states whose fiscal solidity has earned them an excellent credit rating are there to guarantee that the debt will be serviced. One can nearly see it happening already, people going short or long on eurobonds, trading them between Singapore, London, and New York to increase their profits.

Eurobonds are not “pro-European” because the concept is so perfectly tailored to the needs of the financial markets that it disregards the needs of the European Union as a political community based on solidarity and composed of democratic states and peoples. These bonds simulate European solidarity and effect the opposite. What happens if a member of the eurozone will not or cannot repay its debts? If the debts were mutualized, the other eurozone members would have to step in.

This necessary precondition for the introduction of eurobonds completely disregards the findings of political economy, and this is precisely where the problem lies: if countries trust that others will “step in,” the political and financial costs for risky behavior are reduced. Governments could make expensive campaign promises, run up excessive debts, and continue to postpone the adaptation of social safety nets to modern demographics. Fiscal discipline would be lost, at first in just one or two states, but such policies would then spread rapidly. After all, what incentive is there to practice fiscal discipline if one’s neighbors have thrown caution to the wind?

In short, eurobonds create massive perverse incentives. In academic terms one speaks here of “moral hazard,” of a threat to decent behavior. This threat is very real, to the budgets of the eurozone members but also to future generations to whom the “eurobonds generation” would foreseeably bequeath a gigantic mountain of debt. This is not what fiscal sustainability and democratic intergenerational justice look like.

Realistically, eurobonds are not on the horizon anyway. Germany is just as unlikely to reach a two-thirds majority in the Bundestag as the eurozone is to reach unanimity. Both, though, would be absolutely necessary for their introduction. And yet we can be sure that the EU’s groundhog will be brought out again next year. After all, old traditions die hard. – By Alexander Graf Lambsdorff


Franziska Brantner is parliamentary secretary of the Greens’ Bundestag caucus. Alexander Graf Lambsdorff is deputy chair of the Free Democrats’ (FDP) Bundestag caucus.