Abstract
The Covid-19 crisis has radically changed the game for world and EU-economies, and urged for a reappraisal of the guidelines for a healthy management of public expenditure. This requires a deep rethinking of the role of public debt in modern capitalistic economies and of efficient, equitable and politically viable ways of financing it. This paper outlines the main operating framework of a Debt Agency tasked with the management of the Eurozone sovereign debts and the creation of a truly European safe asset. The framework leverages on the potential irredeemable nature of sovereign debts in order to build a common bond. By structurally filtering liquidity risk, the Debt Agency can price the Member States’ funding costs by referring only to their credit risk, as defined by EU agreed rules. The common bond issued by the Debt Agency thus avoids mutualisation by design; hence, it can be directly bought by the ECB. Due to its structural intertemporal sustainability, the Debt Agency’s framework delineated in this paper can serve as a benchmark for institutional and political decisions. In this perspective, a counterfactual exercise has been conducted in order to evaluate the future potential impact of the Debt Agency as well as the past distortions in market pricing of Member States’ fundamental risk due to market mispricing of the liquidity risk.
Highlights
Eurozone debts and EurobondsThe Covid-19 emergency has proved to be a watershed in how the issue of fiscal policy and its financing is addressed (Baldwin & Di Mauro, 2020; Carnazza & Liberati, 2021; Draghi, 2020; ECB, 2020a, b; Galí, 2020; Kapoor & Buiter, 2020; Krugman, 2020; Morelli & Seghezza, 2021; Romer & Garber, 2020; Stiglitz, 2020)
The mix of fiscal expansion recorded to date, combined with the monetary support for its financing (ECB role) highlights a structural problem that gripped the Eurozone even before the pandemic, and especially after the sovereign debt crisis: that is, the problem of a European safe asset (a “safe Eurobond”) able to support the stability of financial markets in times of turmoil (Beck et al, 2011; Bonnevay, 2010; Bruegel, 2020; Brunnermeier et al, 2011, 2017; De Grauwe & Moesen, 2009; Delpla & von Weizsacker, 2010, 2011; Dosi et al, 2018; Giudice et al, 2019; Gros & Micossi, 2009; Hellwig & Philippon, 2011; Juncker & Tremonti, 2010; Leandro & Zettelmeyer, 2018a; Monti, 2010; Ubide, 2015)
In the case of ‘default’ by a Member State, the insurance scheme will provide an amount of capital equivalent to the present value of instalments due from a Member State in state of forbearance for an estimated suitable period We have shown that the Debt Agency framework can perform terms-transformation without incurring ALM risks, doing so through an appropriate mechanism of risk transfer pricing supported by an active role of the ECB.6
Summary
The Covid-19 emergency has proved to be a watershed in how the issue of fiscal policy and its financing is addressed (Baldwin & Di Mauro, 2020; Carnazza & Liberati, 2021; Draghi, 2020; ECB, 2020a, b; Galí, 2020; Kapoor & Buiter, 2020; Krugman, 2020; Morelli & Seghezza, 2021; Romer & Garber, 2020; Stiglitz, 2020). The mix of fiscal expansion (increased debts) recorded to date, combined with the monetary support for its financing (ECB role) highlights a structural problem that gripped the Eurozone even before the pandemic, and especially after the sovereign debt crisis: that is, the problem of a European safe asset (a “safe Eurobond”) able to support the stability of financial markets in times of turmoil (Beck et al, 2011; Bonnevay, 2010; Bruegel, 2020; Brunnermeier et al, 2011, 2017; De Grauwe & Moesen, 2009; Delpla & von Weizsacker, 2010, 2011; Dosi et al, 2018; Giudice et al, 2019; Gros & Micossi, 2009; Hellwig & Philippon, 2011; Juncker & Tremonti, 2010; Leandro & Zettelmeyer, 2018a; Monti, 2010; Ubide, 2015)..
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