Don't Fear 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.