Academic journal article Atlantic Economic Journal

Fiscal Sustainability in the Euro-Zone: Is There a Role for Euro-Bonds?

Academic journal article Atlantic Economic Journal

Fiscal Sustainability in the Euro-Zone: Is There a Role for Euro-Bonds?

Article excerpt

Introduction

The financial crisis that started in mid-2007 affected most of the Eurozone countries. This led to an increase in budget deficits and consequently triggered a sovereign debt crisis. The sovereign debt crisis started in Greece in 2009, then spread and affected many Euro countries. The contagion from the peripheral countries of Ireland and Portugal has affected some of the core Euro countries such as Italy. In addition, the exposure of European banks and financial institutions to sovereign debt has caused detrimental market instability that has compelled the governments of these countries to pass austerity measures aimed at addressing the budget deficits. In order to ensure a definite end to the crisis, and avoid a default and a threat to the Euro, a decisive and effective action that will lead to the fiscal sustainability of these countries needs to be taken. Fiscal sustainability (1) is of general concern to both policy makers and the business community as an unsustainable fiscal stance will lead to the governments' inability to alleviate their debt ratios. If the situation persists, it could lead to a state of insolvency.

Empirical work on the fiscal sustainability of individual Euro countries has produced contradictory results. For example, Papadopoulos and Sidiropoulos (1999), (De Castro and &. De Cos, P. H. 2002), Trachanas and Katrakilidis (2013), (Arghyrou and Luintel 2007), Bajo-Rubio et al. (2009), and Legrenzi and Milas (2012) have found evidence that supports the existence of fiscal sustainability in countries that include Greece, Italy, and Spain. (Alfonso 2005) and Corsetti and Roubini (1991), on the other hand, reported results that indicate non-sustainability of the fiscal position of the countries. In then-recent work, (Benassy-Quere et al. 2013) have shown that the presence of systemic banking risks can significantly affect a country's fiscal sustainability.

Fiscal discipline within a monetary union is fundamental because if one country diverges, it will affect other members of the union. This, therefore, calls for an explicit fiscal discipline criteria and fiscal co-ordination mechanism. If a country is fiscally irresponsible, it will threaten the interests of the entire union since the other member-countries will be required to bear the costs of financing its debt. Consequently, a country that is in a monetary union will no longer be able to monetise its debt. The imposition of fiscal discipline is essential for the survival of the union. It is to this end that fiscal consolidation of the Euro countries is advocated. (Arestis et al. 2002).

This paper extends the existing literature on the fiscal sustainability of the Eurozone by empirically testing the sustainability of the Eurozone as a whole and testing the impact of Eurobonds, which has been largely overlooked by the existing literature. In addition, the impact of Eurobonds was analysed within the individual country context. The results indicate that only three core Euro countries; Germany, Finland and Austria exhibit characteristics of medium- and short-run fiscal sustainability. The Netherlands, France, Spain, Portugal and Ireland are found to be weakly sustainable. (2) This means that without changes in fiscal and structural policies, these countries' positions will deteriorate. Italy and Belgium, on the other hand, appear to be structurally unsustainable due to their large accumulated stock of debt. Drastic actions aimed at decreasing the stock of debt of these countries are required in the short-run whilst pursuing economic reforms for the long-run sustainability. The situation is more urgent in the case of Italy than it is in Belgium. Generally, the results obtained from estimates that included the Eurobonds have greatly improved the fiscal sustainability of these countries, but the results are sensitive to the rate of interest used. (3) The empirical evidence, therefore, backs the view that consolidating national debts of the Euro countries will help in addressing the fiscal sustainability issue among the members. …

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