The purpose of Eurobonds
Eurobonds can be issued to provide new resources or to become the safe asset for the European financial market, not both. A commentary by Lorenzo Bini Smaghi
Eurobonds — European debt securities — are periodically revived as a panacea for all of Europe’s problems. This creates confusion.
In reality, Eurobonds can serve two main purposes. The first is to raise funds to finance public spending, either at the national or European level.
The second is to create a low-risk, euro-denominated financial asset that is liquid and available in sufficient quantity to serve as a benchmark for the European financial market — capable of competing globally with the dollar.
These two goals require different choices and instruments.
The first objective — expanding the capacity to fund common goods such as defence, environmental transition, or digitalisation — necessitates the creation of a sizeable European budget. However, this requires transferring decision-making powers from the national to the EU level, something few member states are currently willing to accept.
Alternatively, the Next Generation EU model might be followed, which funds national spending programmes such as the Recovery and Resilience Plans through common debt, overseen by EU institutions. Even in this case, however, fiscal resources must be transferred to the European level, particularly to cover interest payments on the debt.
The European Commission has proposed increasing its own resources, specifically through three new revenue streams (based on corporate taxation and CO₂ emissions) to finance Next Generation EU, but the European Council has not yet decided.
As long as the resources are not found to guarantee the debt already issued, it is illusory to think that more European debt can be created.
The second rationale for issuing Eurobonds is to create a so-called “safe asset” — a secure financial instrument that would serve as the foundation of an integrated European capital market and provide an alternative to the dollar.
This would reduce risk across all European sovereign bonds and better shield the continent from external shocks. It would also strengthen Europe’s strategic autonomy.
The challenge, as ECB President Christine Lagarde has recently pointed out, is that Europe has a limited supply of sovereign bonds considered “safe” — that is, with a rating of AA or higher (the maximum being AAA). Eurozone countries’ safe assets amount to around 50% of GDP, compared to more than double that in the United States.
However, what really matters is not so much the volume of safe assets. Even when US debt was below 60% of GDP — more than 25 years ago — dollar-denominated Treasuries were already the global benchmark. Europe’s real problem is market fragmentation.
Member states’ sovereign bonds are illiquid, issued under diverse conditions and maturities, and not easily tradable. Moreover, a new European spending programme funded with common debt would not solve this fragmentation.
What is needed is a new European security, amounting to at least €5 trillion — roughly one-third of euro area GDP. The only viable way to achieve this is to issue a new asset in replacement of part of the sovereign bonds currently held by member states.
Two economists, Olivier Blanchard and Angel Ubide, have recently proposed that the European Commission issue new Eurobonds and use the proceeds to purchase national sovereign bonds available in the market.
This would not imply fiscal transfers between countries since, even in the event of a default by one of them, the European Commission would be protected thanks to its status as a preferred creditor.
In this case, however, the cost of a default would be borne by the other creditors, which might increase the risk premium on countries’ bonds.
An alternative solution is for the European Stability Mechanism (ESM) to issue Eurobonds. The ESM has substantial capital that can be called in — over €600 billion — enabling it to issue a significant volume of high-rated securities.
With the funds raised, the ESM could purchase sovereign bonds from euro area member states at the market price. In the extreme event of a default, the ESM would have to be recapitalised by the country in question, possibly through an ESM loan.
This would require a change in the ESM’s statutes and functions. This could be an opportunity to break the deadlock that followed Italy’s veto of the previous reform, and to relaunch a broader discussion on how the ESM can be fully deployed in the service of Europe’s strategic sovereignty.
IEP@BU does not express opinions of its own. The opinions expressed in this publication are those of the authors. Any errors or omissions are the responsibility of the authors.
