Don't Sweat the Bond Markets
The ongoing eurozone debacle has driven home certain straightforward lessons: the fiscal rules enshrined in the EU's 1997 Stability and Growth Pact had almost no teeth, government bonds of EU nations are not a risk-free asset, and voters do not readily tolerate economic austerity. Beyond these, however, the last few years have also contained subtle lessons about the relationship between governments and capital markets. More specifically, they have shown that our understanding of the pressures that private capital markets place on governments is incomplete. Although holders of government debt certainly would react markedly to a change in the membership of the eurozone, they would not likely react strongly, or over the longer term, to many other government policy decisions and political outcomes. And these reactions have varying consequences for governments, depending on how governments have managed their debt profiles. Were the move toward eurobonds to come to fruition, some of these debt management decisions presumably would be made by EU-level, rather than national, authorities.
All governments borrow money, but they structure their borrowing in different ways. In the late 1980s and early 1990s, many developed nations, including France, Germany, Ireland, and the United Kingdom, began to establish autonomous debt management offices. These offices are often located within the country's central bank or finance ministry, and are staffed by experts in capital markets, not in politics. The mandates of these offices typically include two sometimes contradictory objectives: minimizing the governments' borrowing costs and keeping rollover risk (the risk associated with refinancing debt) at an acceptable level. Debt managers who focus largely on minimizing borrowing costs issue more short-term debt than long-term debt, especially when short-term borrowing is significantly cheaper than long-term borrowing. (Such a steep yield curve occurs, for example, when investors expect significant inflation, which erodes the real value of bond repayments.) When debt management offices focus on reducing rollover risk, however, they borrow at longer maturities and in a way that is evenly distributed over time. That strategy means that governments will need to finance their debt less frequently. Many debt management offices attempt to balance these two objectives; often, the weight given to each varies across countries and over time.