A cheap moratorium on stigma in eurozone debt

Thomas Colignatus
January, 28 2012 

The EU is in a pressure cooker with interest rates that suffer from stigma, i.e. irrational fears of default that become rational and self-fulfilling because the higher rates of interest imply a reward. A moratorium arises by temporarily allowing eurozone bonds for 3% of GDP per annum to cover deficits. This buys time and rest to think through a structural solution. A dash for a fiscal and political federation may be ill advised because of the risks of resentment.

Decision making in the EU now takes place in a pressure cooker. There is a large risk that wrong decisions are taken that make the situation only worse. In the last five years EU leaders have wandered about from one crisis to the other, also created by themselves. They now recognize for example that the "voluntary default" on Greek debt was not so wise. Kanzler Merkel last week expressed her preference for a fiscal and political federation but this has a risk too. The transfer of national souvereignty would take place under the current conditions of austerity and depression in Southern Europe, such that the European project may become a dictate disliked by Europeans instead of the community that everyone welcomes. Historically Europe’s greatest danger is resentment. And such a federation might actually not be really needed just now.

The current high rates of interest derive from stigma, i.e. irrational fears of default that become rational and self-fulfilling because the higher rates of interest imply a reward. The key problem in the eurozone is that there is no structural mechanism yet to eliminate stigma. The pressure cooker in fact also encourages stigma. Problems with rates of interest are a weak argument for a political federation.

There is a straightforward manner to buy precious time to relax and discuss structural reform at ease. The manner is this: allow eurozone members to borrow 3% of GDP per annum, for the next 10 years, with full backing by the ECB. Since old debt is already in the hands of market counterparties, it is not quite as relevant, and it are only the new deficits that are important for the annual budgets of the member states. With the backing by the ECB the rates of interest in the eurozone can drop to an acceptable low level. Italy, Spain, Portugal and Ireland are immediately saved and we get a clearer picture of what can be done about Greece. After those 10 years only 30% of their GDP will be have such backing by the ECB, so that coverage is limited and the "no bail out" condition still is satisfied.

This moratorium actually uses eurozone bonds. Proponents of eurozone bonds generally want them structurally and not just for a moratorium. Earlier I advised against such bonds since they destroy important market information. For the purposes of this moratorium they however form an instrument that everyone understands and that is immediately effective. My own structural analysis leads to the suggestion of a regime ladder, with different stages depending upon the distance from the target of 60% of debt to GDP. However, my structural analysis is only one of the many approaches. The idea of the moratorium is to create more time to evaluate all of them, also using what we have learned about how a crisis can evolve.

There is a moral hazard that some member states will take advantage of this moratorium and not participate in the creation of a structural solution. It is more likely however that the whole of Europe now is aware of a need for a structural solution. Nevertheless it would be possible to define phases, say 1 year for job creation and agenda setting, and subsequently 3 periods of 3 years for aspects to develop in full - say on investments, banks, governance - and decide in unanimity whether there is sufficient progress to continue with the moratorium.

This proposed moratorium comes at a cost for Germany and Holland. Their rates of interest are exceptionally low now because of the fears about Southern Europe. Europe as a whole could ask Germany and Holland to accept normal rates of interest again to create this moratorium. Given Kanzler Merkel’s objectives and given that the "no bail out" clause is satisfied, it would be a wise decision. It will be the best news that Europeans have heard since all this started in August 2007. 


Colignatus is the name in science of Thomas Cool, econometrician in Scheveningen, Holland. 

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