After pulling back from an almost existential crisis, the euro area is growing again. However, it remains the worst economic performer of the major advanced economies, barely reaching its precrisis level of GDP. Meanwhile, public opinion on the euro has recovered, but it remains vulnerable to another shock. The rules and buffers created in the last few years to enable the euro area to withstand another sudden stop of credit and market-driven panic in one or more of its member states are welcome steps, but they are widely recognized as inadequate. As Finance Minister Emmanuel Macron of France has said, “Without any change, the euro zone cannot survive.”1 Mario Draghi, president of the European Central Bank (ECB), has also declared that a “minimum requirement” for survival of the euro area is for its member states to “invest” in “mechanisms to share the cost of shocks,” so that “all countries can retain full use of national fiscal policy as a countercyclical buffer” (Draghi 2014).
But what kinds of “mechanisms” are appropriate—or politically feasible—in a region where many people are skeptical 1. Ferdinando Giugliano and Sarah Gordon, “Macron calls for radical reform to save euro,” Financial Times, September 24, 2015, www.ft.com. about any sort of mutualized backstop for countries that get into financial trouble? The diversity of European economic cycles, economic structures, and political dynamics is both a strength and a weakness of the euro area as it struggles to achieve a true monetary, fiscal, and financial union. It will not be easy to put in place arrangements that distribute risks and ensure that all countries can use fiscal policy to cushion economic downturns (Ubide 2015b). Yet such arrangements are necessary and urgent to ensure that, when the next recession arrives, markets don’t force countries to adopt the fiscal policies—raising taxes and cutting spending while in a recession—that inflicted so much economic and political damage during the recent crisis.
A step toward addressing these concerns, this Policy Brief argues, would be the creation of a system of stability bonds in the euro area, to be issued by a new European Debt Agency (EDA) to partially finance the debt of euro area countries, up to 25 percent of GDP. These stability bonds should be initially backed by tax revenues transferred from national treasuries, but ultimately by the creation of euro area–wide tax revenues, and used to fund the operations of national governments. They could also be used for euro area–wide fiscal stimulus, to complement the fiscal policies of the member states. Such bonds would strengthen the euro area economic infrastructure, creating incentives for countries to reduce their deficits but not forcing them to do so when such actions would drive their economies further into a downturn. They would permit the euro area to adopt a more flexible or expansionary fiscal policy during recessions.