Why Eurobonds will never fly without credible fiscal enforcement

A total of 18 EU countries have now requested activation of the national escape clause for defence spending, while Italy and Spain are pushing to extend that fiscal flexibility to absorb the budgetary impact of the latest energy shock triggered by the war in Iran.

The first year of the newly adopted fiscal rules has been described by the European Fiscal Board as one of fiscal indulgence rather than consolidation. In parallel, calls for Eurobonds are intensifying. 

The intuition behind those calls is understandable. The union faces structural pressures that 27 national budgets are ill-equipped to finance on their own, such as defence or energy security.

The EU’s long-term budget (MFF) remains capped at around 1.1 per cent of EU gross national income. The combined stock of euro-denominated AAA sovereign and supranational safe assets is roughly one seventh of the US Treasury market. The demand for additional common fiscal capacity is therefore both economic and strategic.

Yet the conditions under which Eurobonds could become a credible instrument are not in place.

“Before more common borrowing for new expenditure becomes credible, a visible reorientation of EU spending towards genuine European public goods must take place”

The two principal forms of common borrowing now under discussion — to finance new EU spending, and to refinance part of the existing national stock of debt — both run into difficulties that the current fiscal framework cannot resolve. Building either on top of a rules regime whose enforcement is already strained would put the cart before the horse.

Eurobonds for new spending

The argument for common borrowing to finance new EU expenditure is analytically sound. Genuine cross-border public goods cannot be adequately provided through national budgets, and common debt is the natural way to finance them.

Implementation is the difficulty.

The track record of common EU spending has been more redistributive than directed at the provision of European public goods.

The Common Agricultural Policy and cohesion funds still account for around two-thirds of the current EU budget.

The recovery funds (NGEU), the most ambitious common borrowing exercise to date,  produced not so much European public goods as common European financing of national goods.

SAFE, the €150bn defence loan facility adopted in May 2025, moves closer to a genuinely European function, but remains a loan-only instrument with a four-year horizon.

There is also a constitutional point that is too often skipped. The expenditure-intensive functions of modern government — pensions, healthcare, education, the bulk of social protection — are national competences.

The union acts under the legal principles of conferral, subsidiarity, and proportionality.

Comparing the size of a typical national budget, around 40 per cent of GDP, with the EU budget at 1.1 per cent and inferring that the latter is implausibly small misstates the question.

The relevant standard is not the size of national budgets, but whether common spending finances functions for which Union-level action has clear value added.

Before more common borrowing for new expenditure becomes credible, a visible reorientation of EU spending towards genuine European public goods must take place.

The 2028–2034 MFF will be the first test of whether that rebalancing can be delivered.

Eurobonds to refinance existing debt

The second variant is more sophisticated. Several recent proposals in the academic-policy debate have explored the conversion of a portion of national sovereign debt into a jointly backed European instrument, typically with safeguards against moral hazard, such as earmarking a share of national VAT revenues to service the common bond.

The intellectual attraction is the creation of a deep and liquid European safe asset, which would strengthen the international role of the euro and improve the transmission of monetary policy.

The political difficulty lies in two places. The first is the incentive structure.

Germany is already committed to a substantial increase in Bund issuance over the coming years to finance its defence build-up and its infrastructure programme. Because the Bund is the closest thing the euro area has to a benchmark safe asset, this expansion will in itself enlarge the available supply of high-grade euro-denominated debt. The marginal value of a new common instrument, therefore, falls precisely from Germany’s perspective.

The second difficulty is the contingent reliability of the safeguards. Proposals that envisage the transfer of, say, one percentage point of national VAT to service common bonds depend on member states honouring that transfer through every cycle, including in periods of severe domestic fiscal stress.

The historical pattern of EU fiscal governance is not encouraging on this point. Where political costs become acute, commitments tend to be renegotiated rather than honoured. 

Both options run into the same underlying problem: the credibility of national fiscal discipline. Europe’s fiscal rules have been redesigned many times, but the core weakness has repeatedly been political enforcement.

The 2003 episode involving France and Germany, the zero fines for Spain and Portugal in 2016, the negotiated avoidance of an excessive deficit procedure for Italy in 2018 and 2019, and the long suspension of the framework during the pandemic all point in the same direction.

The binding constraint has not only been the technical design of the rules. It has been the willingness to apply them when doing so is politically costly.

The 2024 fiscal rules represent a new serious attempt at a redesign, but enforcement prospects are not very promising. Until the new rules establish a track record of consistent enforcement, including against the largest member states, common borrowing on a permanent basis will continue to encounter the same political resistance it has met for two decades.

A more modest, more feasible step

There is, however, a step the Union can take now without prejudging the broader debate.

The supply of euro-denominated AAA safe assets is today fragmented across distinct supranational curves: the European Stability Mechanism (ESM), its predecessor the European Financial Stability Facility (EFSF), the European Commission on behalf of the EU, and the European Investment Bank (EIB).

Each issues with its own benchmarks, maturity profile and investor base. Greater integration of these existing supranational issuers — beginning with the ESM, EFSF, and commission borrowing, and exploring how the EIB curve could be aligned — would deepen the pool of available safe assets.

This is not the equivalent of a single European safe asset. It will not, on its own, close the gap with the US Treasury market. But it is feasible. Above all, it is consistent with the rule of public finance that the union has, after considerable effort, finally relearned: enforcement first, capacity afterwards.