Towards Greater Fiscal Union?: The Context and Precedent for Joint European Bonds

While there has been much speculation amongst academics, journalists, and policymakers about the potential benefits of pooling European debt into so-called “Eurobonds,” there has been relatively little examination to date of the context or precedent of joint sovereign borrowing. Drawing on existing political economy theories of sovereign debt and several examples, this article argues that enhancing debt commitments through alliances and guarantees is an alternative and highly effective way to generate credibility. In fact, the rapid and dramatic convergence of Eurozone sovereign borrowing rates to those akin to Germany at the outset of the euro project is a prime example of the market assuming a higher level of financial support than existed in practice (as is evident from the equally rapid divergence of sovereign bond spreads in the past two years, once it became clear that bailouts and mutualization of debt would not be automatic). In this context, the article analyzes the bonds issued in 2011 through the European Financial Stability Mechanism to finance the support packages for Ireland and Portugal. The objective is to determine how these bonds are being priced and traded by market participants in order to help gauge the potential impact and success of future European joint sovereign bonds.