How Can we Contain the European Debt Crisis? FIRE instead of Eurobonds: A New Solution Concept to Tackle the European Debt Crisis

Europe should address the crisis of confidence at the European bond

markets through a direct equalisation of interest rates. Such a solution,

as suggested by Friedrich Heinemann, rules out the collective liability of

Eurobonds and is affordable even if applied to Spain and Italy.

PD Dr. Friedrich Heinemann is the head of the Research Department of Corporate Taxation and Public Finance at ZEW. His research focuses on empirical public economics, federalism in Europe, and tax competition. In 2010 he received his venia legendi for economics from the University of Heidelberg. Along with work in several research groups, Heinemann is a board member of the Arbeitskreis Europäische Integration e.V. and a member of the Scientific Board of the Institute for European Politics in Berlin.

What is the central idea of your recent proposal?

The basic idea is that countries like Germany and the Netherlands use a part of their crisis-related interest savings to ease the interest burden of countries with particularly high interest rates. The money of the countries benefiting from historically low interest rates would flow into the “FIRE Fund”. “FIRE” is the acronym for “fiscal interest rate equalization”.

Countries in crisis would receive a compensating amount when their bond issuances suffer from market interest rates exceeding a critical level. This support would be granted for one year subjected to conditions. FIRE programmes would only be extended if the benefiting country would be able to submit proof of its reform progress.

What benefits would you expect if this approach was put into practice?

The establishment of such a FIRE Fund would result in an acceptable interest burden for new bond issues of troubled countries. Their efforts for consolidation would no longer be undermined by the high interest rates on the market.

What are the advantages of FIRE, compared to Eurobonds?

Eurobonds work with joint and several liabilities whereas FIRE does not imply any kind of mutual guarantee. As opposed to Eurobonds, FIRE only reduces spreads in interest rates, it doesn’t entirely eliminate them. Transfers within the FIRE approach are, in sharp contrast to the hidden subsidies coming with Eurobonds, completely transparent. Transparency would reduce the danger of troubled countries relying on permanen support and slowing their reform efforts.

How expensive would FIRE be for German taxpayers?

Germany would come off cheaper with this system. Eurobonds imply a total interest rate levelling and thus conceal a significantly higher transfer volume. My own calculations show that the elevated interest burdens of the troubled countries are comparable in size to the savings of the creditworthy countries.

Can you give a specific size?

Assuming that FIRE finances a cap on Italian and Spanish interest rates at five per cent, this would require an annual equalisation payment of 5.7 billion eurs for these two countries’ 2012 issues. The financing would be split among Germany (90 per cent), the Netherlands (8 per cent), and Finland (2 per cent), according to the advantages each country draws from low interest rates. For all these reasons FIRE would be the better way compared to an extension of liability, notwithstanding the burdens linked with this concept.