Working Paper: CEPR ID: DP9860
Authors: Rui Esteves; Ali Coskun Tuncer
Abstract: Debt mutualisation through Eurobonds has been proposed as a solution to the Euro crisis. Although this proposal found some support, it also attracted strong criticisms as it risks raising the spreads for strong countries, diluting legacy debt and promoting moral hazard by weak countries. Because Eurobonds are a new addition to the policy toolkit, there are many untested hypotheses in the literature about the counterfactual behaviour of markets and sovereigns. This paper offers some tests of the issues by drawing from the closest historical parallel?five guaranteed bonds issued in Europe between 1833 and 1913. The empirical evidence suggests that contemporary concerns about fiscal transfers and debt dilution may be overblown, whilst creditors' moral hazard may be as much of a problem as debtors'.
Keywords: debt dilution; debt mutualisation; eurobonds; moral hazard; pre-1913
JEL Codes: F34; H63; H77; N24; N44
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Dilution of previous claims on sovereign debt (F34) | Increased competition for existing creditors (F65) |
| Market's initial reception of guaranteed bonds (G10) | Pricing at yields lower than the average of the guarantors (G19) |
| Long-term pricing of guaranteed bonds (G12) | Not influenced by sovereign risk of the issuing country (F34) |
| Introduction of guaranteed bonds (H74) | Dilution of previous claims on sovereign debt (F34) |
| Introduction of guaranteed bonds (H74) | Increase in yields on existing non-guaranteed bonds (G12) |
| Introduction of guaranteed bonds (H74) | Decrease in yields for guaranteed issues (G52) |
| Long-term pricing of guaranteed bonds (G12) | Influenced by credit risk of the guarantors (G33) |