The European Redemption Fund Proposal

The proposal for a Debt Redemption Fund made by the German Council of Economic Experts seems to be gaining a bit more traction (see here).   This working paper from February provides a useful overview.   Given that this is the only “eurobonds” proposal with anything approaching momentum, it is worth debating its merits. 

Some of the basic elements:

·         Countries would be able to finance an amount of debt (as a share of GDP) equal to the difference between current levels and 60 percent of GDP through the fund.   This would occur as new funding needs (deficits/redemptions) arise

·         The fund would have joint and several guarantees

·         Repayments would be a constant share of GDP, equal to the ERF interest rate plus one percent divided by initial GDP.   The repayment schedule is designed to fully repay fund borrowings in 20 to 25 years

·         Countries would have to commit to reduce their total debt to below 60 percent of GDP.   Longer term, it doesn’t appear that there would be additional commitments beyond the revised Stability and Growth Pact and Fiscal Compact.   However, during the “roll-in” phase, countries would have EFSF-style adjustment programmes

·         Would only apply for current programme countries after they had exited their programmes. 

From the working paper:

Transferring debt into the redemption fund is organized by allowing participating member countries to refinance themselves through the redemption fund until the amount of debt refinanced through the ERF reaches the current difference between the debt accumulated to date and the hypothetical debt that would just equal 60 % of GDP, i.e. the SGP debt threshold . . .. The exact length of this transitional phase depends on the sequence of immediate refinancing needs. During this so-called roll-in phase, the participating countries fulfil consolidation and reform agreements which are comparable to the structural adjustment programmes of the EFSF. While each country will henceforth have to service its own debt financed via the new fund until it is completely redeemed and the new fund expires, participants will be jointly liable for the debt, thus ascertaining affordable refinancing cost for all participants.  

Payment-obligations through which the transferred debt is redeemed are expressed as a constant fraction of GDP. The scale of annual payment-obligations relates to the volume of transferred debt. It is set at a level that ensures that each country redeems its debt in the ERF within a period of 20 to 25 years. Accordingly, countries transferring more debt have to bear higher annual payment-obligations. As the ERF can only gain the trust of financial markets if the joint and several guarantee is upheld until the transferred debt is completely redeemed, payment obligations have to be constructed in a way that all participating countries complete the redemption of their debt inside the ERF at approximately the same time. 

By agreeing to redeem their debt in the redemption fund within 25 years and to keep the remaining debt below the 60 %-threshold, participating countries implicitly commit to certain upper limits for their primary balances and debt quotas. The exact development of these figures depends on several assumptions on GDP growth and country specific refinancing costs. In addition, required primary balances are determined by the sequencing of refinancing needs that each country is allowed to cover through the redemption fund during the roll-in phase. In general, there are several options to implement the ERP, which differ mainly in the exact sequencing of refinancing via the funds.

9 thoughts on “The European Redemption Fund Proposal”

  1. Of interest to note that Spiegel is running this week an article on quite another type of fund with some interesting characteristics .. Such product of course is always conceivable; but it is tricky in practice to avoid icebergs like subordination and crowding out of present issuance, along with fiscal moral hazard (which I’d argue has been the outcome already from current support mechanisms).

  2. How many different means are there to create a plan where Germany pays up front, and the insolvent nations promise to forever be German and fully pay back later? The only truly novel aspect of this plan is that it originated from Germany. Like all the others, I would guess it is heavily debated and then rejected by Germans.

  3. I do not think that this issue is at the forefront of the politial debate in Germany at the moment. It is much more concerned with the tug-of-war going on with regard to ratification of the ESM. The SPD and the Greens are insisting on the introduction of an FTT as the price of their support. The governments of the laender are also trying to extract concessions from the federal government in return for the agreement of the Bundesrat.

    The governing coalition appears to have decided to call their collective bluff this weekend, against the background of the head of the Bundesbank saying that such a tax would simply be passed on to customers, intimating that such a tax could not be introduced before the next federal election.

    Good news for Ireland on at least one front.

  4. @ciaran o’hagan

    Surprised myself at my Italian connections who are opposed to anything but the return of the lire. Great deal of opposition to Monti who finishes on November 14th by business (not by sham businesses). Next elections should prove interesting.

    @John McHale, Phillip Lane, Seamus Coffey, Stephen Kinsella, Kevin O’Rourke, and the very few others. Thank you for assuming the thankless task of keeping this forum going. At a distance it is very useful.

    It seems to have a huge number of listed academics judging from the sidebar but maybe they haven’t had time to contribute yet. Come back.

  5. The European redemption proposal – special Eucharistic Congress version

    Oh, most holy apostle, St. Jude, faithful servant and friend of Jesus, people honor and invoke you universally as the patron of hopeless cases, of things most despaired of. Pray for the eurozone for it is so hopeless and alone. Please bring it visible and speedy assistance. Come to its assistance in this great need that it may receive the consolation and help of heaven in all necessities, tribulations, and sufferings, particularly (state your case but include continued funding and political ineptitude ) .

  6. “Countries would have to commit to reduce their total debt to below 60 percent of GDP.”

    Since we use debt as our money, policy would have to simultaneously nerf people’s savings. Designing such a policy would be hard, but maybe not impossible. All pension saving would have to go. People would have to be poor in monetary terms. Not a desirable outcome in my opinion but apparently policy makers don’t think so.

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