Abstract
This paper assesses the fiscal sustainability of ten Eurozone member countries at a national and aggregate level. It is carried out in light of the relevant literature on monetary unions and the framework of the European Monetary Union vis-à-vis the current sovereign debt crisis. The impact of Eurobonds, which are considered as a viable solution, on fiscal sustainability was empirically tested. The results indicate that only three countries appear to be structurally sustainable whereas the majority of the countries are only sustainable in the short-run and two countries are structurally unsustainable. However, the sustainability of the Eurozone is greatly improved when the Eurobonds are used.
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Notes
There is little consensus on what fiscal sustainability means. For example, see (Alfonso 2005), Arestis, et al. (2002) and (Arghyrou and Luintel 2007) for detail discussion on the concept. However, for clarity, fiscal sustainability, as used in this paper, refers to a government’s capacity in executing a set of fiscal policies whilst remaining solvent. Therefore, a country is considered to be fiscally sustainable when the ratio of its public debt to GDP is stationary and consistent with demand for government securities.
These countries, except Ireland, are among the countries that the European Commission recommended to the Council to extend deadlines for correcting their excessive deficit. See European Commission - MEMO/13/463 29/05/2013 available here: http://europa.eu/rapid/press-release_MEMO-13-463_en.htm.
There are two options, either to use the national interest rates or German interest rates. We have used both in this paper. See Discussion for details.
“Blue bond” refers to Eurobonds that are jointly issued by Euro countries up to 60 % of their GDP, which will be repaid under all circumstances. They will be fully guaranteed and enjoy super-safe AAA rating. Eurobonds issued above 60 % of GDP would have to be issued in the national bond markets and labelled “red bonds”. This is a junior tranche that will face a higher risk premium. For full discussions on the proposed Eurobonds, see (Delpla and von Weizsäcker 2011) and (De Grauwe 2012).
We have calculated the ratio of spread in interest rates to change in growth. If the interest rate on government debt increases faster than economic growth, then a country is becoming unsustainable. This is similar to the Present Value of Borrowing Constraint, PVBC constraint (Alfonso 2005). The ratio calculates the average spread of interest rates (on long term government yields) of EMU member countries with that of Germany’s. The spread on interest rates on bond yields had substantially decreased at the start of the Euro. The results indicate that the average spread of interest rates with reference to German rate, in 1980–1991 was 57.12 %. In 1992–1999 it fell to 29.55 % in 2000 and reached 2.60 % in 2006. However, it increased again in the last period to 22.28 %. It was only Luxembourg that had interest rates lower than Germany between 2000 and 2006.
The results at the national level are consistent with the ones reported on Italy and Spain by Trachanas and Katrakilidis (2013) who studied fiscal sustainability of Greece, Italy and Spain.
This is discussed in Section 2.
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We are very grateful for the referee’s as well as the editor’s helpful and constructive comments. We also thankfully acknowledge invaluable suggestions that we received from Bruce Morley
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Ahmad, A.H., Fanelli, Sl. Fiscal Sustainability in the Euro-Zone: Is There A Role for Euro-Bonds?. Atl Econ J 42, 291–303 (2014). https://doi.org/10.1007/s11293-014-9416-4
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DOI: https://doi.org/10.1007/s11293-014-9416-4