Score contribution per author:
α: calibrated so average coauthorship-adjusted count equals average raw count
This paper proposes that all new euro area sovereign borrowing be in the form of jointly guaranteed eurobonds. To avoid classic moral hazard problems and to insure the guarantors against default, each country would pay a risk premium conditional on economic fundamentals to a joint debt management agency. This suggests that these bonds be called ‘euro-insurance bonds’. While the sovereign debt markets have taken increasing account of the economic fundamentals, the signal-to-noise ratio has been weakened by huge market volatility, so undercutting incentives for appropriate reforms and obscuring economic realities for voters. This paper uses an econometric model to show that competitiveness, public and private debt to GDP, and the fall-out from housing market crises are the most relevant economic fundamentals. Formula-based risk spreads based on these fundamentals would provide clear incentives for governments to be more oriented towards economic reforms to promote long-run growth than mere fiscal contraction. Putting more weight on <italic>incentives</italic> that come from risk spreads, than on fiscal centralization and the associated heavy bureaucratic procedures, would promote the principle of subsidiarity to which member states subscribe. The paper compares euro-insurance bonds incorporating these risk spreads with other policy proposals. Copyright 2013, Oxford University Press.