The Blue Bond Proposal. Bruegel Policy Brief 2010/03, May 2010

How can the euro area's return to fiscal sustainability be organised in view of soaring debt levels and the sovereign debt crisis? How can we finance our debts efficiently, not least to prevent debt crises in weaker countries where high debt levels compounded by a hike in risk premiums on government bonds can create a debt trap? This looks like a classic dilemma. European solidarity with the most vulnerable European Union countries runs the risk of further weakening the incentives for individual countries to pursue fiscally sustainable policies. While not a quick fix, our Blue Bond proposal charts an incentive-driven and durable way out of this dilemma while helping prepare the ground for the rise of the euro as an important reserve currency, which could reduce borrowing costs for everybody involved. Soaring debt levels and the crisis in Greece has sharpened the focus on fiscal sustainability among eurozone members. The European Union has to tackle high debt levels in vulnerable states which are compounded by a hike in risk premiums on government bonds leading to a debt trap, while designing ways to efficiently finance debt. Furthermore, European solidarity with weaker states should not undermine incentives for individual members to pursue fiscally sustainable policies. This Policy Brief proposes a Blue Bond to resolve these challenges. The authors...explain the economics behind their proposal, its institutional underpinnings and the implication of it on various participating countries