“Euro bundles are not a great leap forward to a fiscal union but they could provide an important step towards a more integrated and more resilient European monetary union.” – Peter Bofinger, “A eurozone bond need not be a freeloaders’ charter“
His proposal for a Eurobond, as an instrument of fiscally consolidating the Eurozone, was soundly rejected by the German Chancellor. Now, with an ECB paralysed in the face of a major deflationary onslaught, Professor Peter Bofinger comes up with a variant of the rejected Eurobond, which he calls ‘Euro-bundles,’ only this time as an instrument that will bolster the ECB’s monetary policy defences against deflation; and one that may offer a modicum of hope that the Eurozone can salvage a degree of integrity after four years of fragmentation. What exactly are Mr. Bofinger’s Euro-bundles? In what follows, I sum up his scheme and then pass on the baton to George Krimpas who asks some pertinent questions of Mr. Bofinger. My own views on Euro-bundles will appear in a follow-up post shortly.
Euro-bundles: A primer
Some background to Professor Bofinger’s latest intervention
Peter Bofinger is a rare German economist. From the moment that the Euro Crisis erupted, and while a member of the German Chancellor’s Council of Economic Advisers, he fought a lonely campaign in favour of a common Eurozone bond; a Eurobond; a common bond severally and jointly issued and backed by all member-states. In a recent article in the Financial Times, Professor Bofinger conceded defeat on that fiscal front, acknowledging that (for the time being) the ECB’s OMT has stabilised the Eurozone’s bond markets (the German constitutional court’s recent decision notwithstanding) and strategically abandoned the Eurobond idea. Simultaneously, he opened another front, this time in the realm of monetary policy where, as these lines are written, the ECB is fighting what seems like a losing battle against the forces of deflation. His choice of weapon, with which to bolster the ECB? A version of the (abandoned) Eurobond that he refers to as Euro-bundles.
Political obstacles to a Eurozone version of Quantitative Easing
When Ben Bernanke worried that deflationary expectations would set in and push the US economy into depression, he opted for aggressive quantitative easing (QE). The first wave of QE was based on large purchases of government bonds. The ECB is, belatedly, recognising that the Eurozone is facing precisely the same threat: deflationary expectations that will push the Periphery further into depression and potentially plunge France into a never-ending recessionary posture. Having pushed interest rates to 0.25%, the ECB is in the same liquidity trap as the Fed was in 2009. QE is thus its only monetary policy weapon left. QE can take one of two forms. One is Mr. Bernanke’s QE1 variant, where the central bank buys long term government bonds in order to push down long term market rates. Another is the QE2 and QE3 variant where the central bank shifts its purchases toward mortgage backed securities, bundles of loans, and equities.
The ECB’s problem is that both types arouse serious political strife. While the ECB’s governing board would have a preference for the QE2/QE3 ‘solution,’ it is virtually impossible for them to agree on which assets to purchase and which to leave alone. Will they be French shares or German MBS? Will the ECB focus on Core or on Periphery assets? And if so, what will the mix be? Once again, the lack of anything resembling political union gets in the way of sound monetary policy and forces the ECB governors to make political decisions that they are neither qualified nor authorised to make. As a result, they are paralysed.
Similarly with a QE1 type of response. If the ECB were to purchase bonds en masse, which bonds would it purchase? The mere posing of this question threatens to open a Pandora’s Box. It was only the other day that the German constitutional court ruled that the ECB’s OMT bond-purchasing program violated the ECB’s charter, referring OMT to the European Court of Justice. Startlingly, this furor has erupted even though not a single bond has been, so far, purchased under the OMT. Imagine what would happen if the ECB in fact purchased billions worth of Italian or Spanish or, indeed, French bonds in the context of seeing off the spectre of deflation!
One solution would be for the ECB to purchase all 18 sovereign bonds of the 18 member-states in proportion to GDP; e.g. €100 billion bonds in total, of which €28 billion would be German bunds, €22 billion French bonds. In this manner, the German constitutional court could be placated on the grounds that such purchases could not be seen as a hidden form of bailout of some nation-states at the expense of others; since each one of them would benefit in proportion to the size of their economies. Based on this idea, Professor Bofinger finds an opportunity to bring back from the dead the idea of a Eurobond.
The main idea is that, instead of having the ECB purchase eighteen types of sovereign bonds in proportion to each member-state’s GDP, the ECB buys a single asset that he calls a Euro-bundle.
This Euro-bundle is issued by member-states jointly but without joint liability:
The member countries could issue joint bonds in the form of ‘euro bundles.’ Such a security would package together the bonds of national governments in proportion to the size of their economies, so that a €100 bundle would contain a German bond of €28, a French bond of €22 and so on. Each country would be liable only for its part of the bundle.
As long as each ‘part of the bundle’ corresponds to a single member-state which is fully responsible for it, and carries a separate market-determined interest rate, there is no analytical difference between: (a) the ECB purchasing Euro-bundles issued by the member-states or (b) the ECB purchasing eighteen separate bonds in proportion to each member state’s GDP. But if (a) and (b) are equivalent, why bother? Why go through the rigmarole of creating the Euro-bundles in the first place?
Here is Professor Bofinger’s answer:
Eventually, the market [nb. for Euro-bundles] could grow larger than the individual national bond markets in the Eurozone. This could reduce interest rates, especially for countries whose government bond markets are small and illiquid. Germany could help the new securities gain acceptance by issuing all its new bonds in this form. Based on Germany’s current debt levels and the relative size of the bloc’s other economies, euro bundles could then cover about 90 per cent of the financing needs of eurozone governments. This would make it much harder for investors to move their money out of one country’s bonds and into another’s. Such flows have been a significant source of instability in the past few years. Countries with additional funding needs could still issue their own bonds.
Clearly, Professor Bofinger is using the ECB’s current paralysis vis-à-vis its version of QE in order to resurrect some form of Eurobond. Monetary policy paralysis and the threat of deflation give him his cue to say: We need to re-think Eurobonds. Not only would they have allowed the ECB to bolster its monetary policy against deflation (by buying a common European bond) but they will, at the same time, help the Periphery deal with its fiscal woes. Professor Bofinger is clearly worried about both the ECB’s monetary policy impotence in the face of deflation and fiscal fragmentation. He seizes upon the former in order to revive the idea of Eurobonds, in the weaker form of Euro-bundles, and so as to kill two birds with one stone: “Euro bundles are not a great leap forward to a fiscal union” he concedes “but they could provide an important step towards a more integrated and more resilient European monetary union.”
Professor George Krimpas’ pertinent questions on Professor Peter Bofinger’s Euro-bundles
A pleasantly positive predisposition is welcome in a rather arid “nein” environment, still the proposal must be logically and fully spelled out. Some questions:
The ECB will be the buyer of the bundled bond [BB] so the question of credit rating by agencies or the market does not arise. The BB device simply goes around the difficulty the ECB would otherwise have of choosing where to spend its newly minted money among the Eurozone’s member states. In fact the proposed weighting of the BB reflects the ECB’s own shared ownership which, in turn, reflects the member-states relative GDP levels.
Who would then be the seller?
It looks like a Special Purpose Vehicle [SPV] will have to be created to do the job of mixing the desires of Eurozone member states’ Debt Management Agencies. Professor Bofinger must spell this out properly.
Will the ECB announce, Fed-like, in advance how many of these Euro-bundles it will purchase? Should the issuing of these Euro-bundles by the aforementioned SPV not be a function of such an ‘announcement’? Will it be possible for member states to ask for seasoned debt to be included in the BB thus requiring the rest to fill up the missing part of the BB? When, indeed why, should the ECB sell the BB’s in the market, thus shifting them from its assets to its liabilities? How will the servicing of each country’s BB proportion be monitored [easy] and thereby disciplined [not easy, technical default would not be good for either the BB or the ECB].
There are perhaps more difficult matters arising but the above surely indicate that the apparently simple proposal, though wonderfully motivated, is not simple at all.