The Blue Bond proposal

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 debts be financed 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. Blue Bonds: EU countries should pool up to 60 percent of GDP of their national debt under joint and several liability as senior sovereign debt, thereby reducing the borrowing cost for that part of the debt. Red debt: any national debt beyond a country's Blue Bond allocation should be issued as national and junior debt with sound procedures for an orderly default, thus increasing the marginal cost of public borrowing and helping to enhance fiscal discipline. Independent Stability Council (ISC): Blue Bond allocations to member states are to be proposed by an ISC and voted on by member-state parliaments in order to safeguard fiscal responsibility.