S. Micossi: Sovereign debt management in the euro area as a common action problem
This Policy Brief discusses the question of sovereign debt management in the euro area following the large increase in those debts due to the pandemic crisis and reaches two main conclusions. The first is that sovereign debt externalities remain important in the euro area even in the new environment of permanently lowered interest rates. The second is that these externalities justify common euro area policies to deal with excessive sovereign debt accumulation and the attendant risks to the euro area’s financial stability. Our proposal is that a substantial part of the sovereigns purchased by the European System of Central Banks (ESBC) – in the order of 20% of euro area GDP – could gradually be transferred to the European Stability Mechanism (ESM), without any transfer of default risks, which would continue to fall on national central banks. By rolling over these securities, rather than seeking reimbursement from the issuers, the ESM would make them equivalent to irredeemable bonds. These purchases would be funded by the ESM by issuing its own securities in capital markets. In addition to the national central bank de facto guarantees, these liabilities would be guaranteed by the ESM large (callable) capital and by the existing member states’ guarantee, and therefore the ESM Triple A standing would not be endangered. A European ‘safe’ asset would thus be created without the drawbacks of various other proposed schemes. By bringing a large supply of new high-quality assets to the market, the scheme is likely to relieve the downward pressure on interest rates in the bond markets of low sovereign-debt euro area countries. Financial fragmentation would likely be much reduced, though it is not likely to disappear as long as the European Monetary Union (EMU) architecture remains incomplete.