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EU Public Debt is an EU Public Good
Non-resident fellow, Bruegel economic affairs think tank
The Covid-19 pandemic brought the European Union many challenges and at least one unexpected gift: a fast-track path to joint borrowing. Thanks to the €750 billion Next Generation EU program and its public financing component, Europe found both the money and the political will to backstop the pandemic economy. The indisputable collective shock – and corresponding absence of any perceived moral hazard – allowed conservative member states like Germany and Finland to overcome historic reluctance to merge more of their finances with their neighbors. The payoff has been a strong financial infrastructure that, if managed wisely, can set the EU and the euro on a strong course for decades to come.
Well-designed public debt strengthens a developed economy and its currency
Risk has dominated discussions of whether and how much the EU should borrow collectively. This is like talking only about fire threats when it comes to electricity. While power lines can be dangerous, they also keep the lights on and the houses warm. Likewise, well-designed public debt strengthens a developed economy and its currency. In building NGEU, the EU joined the ranks of the U.S., the U.K. and Japan in being able to borrow money safely, reliably and efficiently. Creating a permanent channel to invest confidently in the euro would raise the relatively new monetary union to a new level.
The European Commission has what it takes
Public debt has to be well-managed to work well. The underlying economy needs to be strong and sturdy, to build investor confidence. Government financial managers must work with the banks, insurance companies and investment firms that buy the securities to make sure the system works reliably and in all financial weather. NGEU has shown that the European Commission has what it takes. In 2021, the EU ramped up its public borrowing dramatically while earning a AAA top rating from major credit-rating companies.
The euro area has long had a strong central bank
The dollar leads the world because it is backed by a strong central bank, a stable and well-regulated banking system, and the security provided by an ecosystem of easily tradeable US Treasury bonds. The euro area has long had a strong central bank. During the global financial crisis it created a strong and credible joint bank regulator. To progress further, it needs to complete its banking union project and take the leap toward creating a permanent safe asset in the form of public debt. Europe and the US are economic partners and global leaders. It’s time for them to become financial market peers as well.
The EU is not (yet) sovereign and financial markets know it
Director of Research, Centre for European Policy Studies (CEPS)
Issuance of EU common debt was taboo until 2020. Since its inception, the EU common budget was designed to be small (about 1% of the GNI) and balanced. EU expenditure is driven by long-term spending plans that always meet the resources available. The pandemic broke this taboo. To rebuild a post-COVID-19 EU, on top of the usual EU budget, the Commission introduced Next Generation EU (NGEU), a plan worth €750 billion. To finance it, the EU is expected to raise up to €800 billion by the end of 2026. The first NGEU bond issuance was a success with a huge final order book. Easy as it was, should financial markets become a recurrent source of financing for EU spending? It is tempting to say yes, but it is more complicated than that.
It is not clear yet which resources will be used to repay debt when the time comes
This idea of EU debt implicitly assumes that the EU needs a larger budget. It is not just because of the pandemic; additional funds should permanently be available. This may be a sensitive point but the purpose and the scope of more extensive EU interventions should be defined, and decision powers allocated. The EU would not have much credibility vis-à-vis financial markets without a federal state or a political union. Neither of them is in sight.
Funding expenditure through debt is not an alternative to increasing EU own resources. Financial markets proved very benevolent during the EU first issuances. But demand largely above the supply and very low interest rates should not be taken for granted. While the current debt is jointly guaranteed by EU member states, the debate on own resources is stalling. None of the current options to increase UE own resources seems to be politically feasible. As a result, it is not clear yet which resources will be used to repay debt and interests when the time comes. The good news is that there is a lot of time until then.
Common EU debt is not impossible but it is a complicated business
The macroeconomic environment has worsened dramatically since 2021. The COVID-19 crisis and the war in Ukraine have hugely increased uncertainty and inflation has reached a 40-year high. Interest rates are increasing and overall market conditions are unlikely to be as favorable as they were a year ago. Greater guarantees may be required to borrow the same amounts, and at the moment they are not readily available. They depend on the willingness of member-states with sound public finances to do so.
Common EU debt is not impossible but it is a complicated business. EU wider issues, related to its design and functioning, should be fixed before assuming that the EU can turn to financial markets in a systematic manner, just like a sovereign state.