Abstract
PurposeThe purpose of this paper is to propose a Clarke-Groves Tax (CGT) type as a remedy to the criticism that the implementation of Eurobonds has raised regarding the risk of undermining fiscal discipline. In this model, a government minimizes its sovereign debt-to-GDP ratio in a given period and decides whether to join a common sovereign debt club. In doing so, it exposes itself to a positive or negative tax burden while benefiting from the liquidity premium involved in creating a secure asset. The authors found that the introduction of this tax may prevent free riding behaviours if Eurobonds were to be implemented. To illustrate this, the authors provide some numerical simulations for the Eurozone.Design/methodology/approachIn the model presented, a government which optimizes a social utility function decides whether to join the common debt club.FindingsThe adoption of the proposed tax could prevent free-riding behaviours and, therefore, encourages participation by those countries with lower debt levels that would have not otherwise taken part in this common debt mechanism. Under certain circumstances, we can expect the utility of all members of this club to improve. The bias in the distribution of gains might be mitigated by regulating the tax rule determining the magnitude of payment/reward. The proportion of the liquidity premium, arising from the implementation of a sovereign safe asset, has a decisive impact on the degree of the governments’ utility enhancement.Research limitations/implicationsThe adoption of a CGT would require Eurobonds club members to reach an agreement on “the” theoretical model for determining the sovereign debt yield. One of the limitations of this model is considering the debt-to-GDP ratio as the sole determinant of public debt yields. Moreover, the authors assumed the relationship between the debt-to-GDP ratio and funding costs to be identical for all countries. Any progress in the implementation of the proposed transfer scheme would require a more realistic and in-depth analysis.Practical implicationsA new fiscal rule based on compensating countries with lower public debt levels could be a way to mitigate free-riding problems if a Eurobond mechanism is to be established.Originality/valueThis fiscal rule has not been proposed or analysed before in a context such as that considered by this paper.
Highlights
The European Central Bank’s balance sheet has not stopped growing since the implementation of the first asset purchase programmes in May 2009. This trend has been intensively strengthened with the Pandemic Emergency Purchase Programme (PEPP) since March 2020
The fear of a new sovereign debt crisis in the Eurozone and the drawbacks of flight-to-quality movements, which generate negative snowball effects, have led to proposals aimed at the mutualization of fiscal risks among EU Member States
On the back of the COVID19 crisis, nine European Member States raised the question of the desirability of issuing Corona-bonds
Summary
The European Central Bank’s balance sheet has not stopped growing since the implementation of the first asset purchase programmes in May 2009. We consider a common sovereign debt (CSD) instrument or a joint and several guarantee bond, whose yield reflects the average fiscal strength of the countries that are part of this club.
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