On ifo’s accountability bonds

In a recent press statement, ifo’s President Clemens Fuest argues for second-tier “accountability” bonds that would allow debt above the current limits of the Maastricht criteria, but with strings attached. From the statement:

Fuest and Becker propose that states only be allowed to finance 0.5 percent of their annual economic output with normal bonds. Should they run higher deficits, the excess debt should be subordinate i.e. it will only be repaid after other debts, must not be bought by the ECB, and should also only be held by banks with higher equity cover.

He continues to argue that such bonds would have far higher interest rates than regular bonds, thus discouraging states from using them to much.

Unfortunately, we have seen the great interest rate convergence across the Euro area prior to the crisis, where spread vis-a-vis German bunds collapsed to almost zero, not accounting for risk differences, because the market participants’ assumption was that states will be bailed-out, and they won that bet because Europe blinked.

Long term interest rates in the MU12, Source: ECB

I do not see how second-tier bonds (a while ago a similar concept was called red bonds) would not be susceptible to the same hazard. Why should anybody assume that a country defaulting on accountability bonds would not be rescued as well?

Any threat of default on sovereign debt is just not credible in Europe given the bailout programmes and the ECB’s quantitative easing. As long as there is this lack of credibility, Europe’s crisis will linger on.

A good thing about Fuest’s accountability bonds is, however, the requirement that only well-capitalised banks may hold them. In fact, we should require this for all, especially top-tier government bonds if we are serious about breaking the doom-loop between national budgets and bank budgets. But there is no need for another class of bonds to make that happen, only political will.

See also the article in Die Welt: https://www.welt.de/finanzen/article162087078/Top-Oekonom-schlaegt-Suenden-Bonds-fuer-Europa-vor.html

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I write about economics and politics. I take Ordnungspolitik seriously. While not blogging, I study monetary unions for my doctorate.

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