Debt Mutualization in the Euro Area: A Quantitative Exploration

DebtMutualizationintheEuroArea:AQuantitativeExploration SakaiAndo,GiovanniDell’Ariccia,Pierre-OlivierGourinchas,GuidoLorenzoni,AdrianPeralta-AlvaandFranciscoRoch WP/23/59 IMFWorkingPapersdescriberesearchinprogressbytheauthor(s)andarepublishedtoelicitcommentsandtoencouragedebate. TheviewsexpressedinIMFWorkingPapersarethoseoftheauthor(s)anddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement. 2023 MAR ©2023InternationalMonetaryFundWP/23/59 IMFWorkingPaper ResearchDepartment DebtMutualizationintheEuroArea:AQuantitativeExploration SakaiAndo,GiovanniDell’Ariccia,Pierre-OlivierGourinchas,GuidoLorenzoni,AdrianPeralta-AlvaandFranciscoRoch* AuthorizedfordistributionbyPierre-OlivierGourinchasMarch2023 IMFWorkingPapersdescriberesearchinprogressbytheauthor(s)andarepublishedtoelicitcommentsandtoencouragedebate.TheviewsexpressedinIMFWorkingPapersarethoseoftheauthor(s)anddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement. ABSTRACT:ThispaperexploresthefeasibilityofanideaproposedfirstbytheGermanCouncilofEconomicExpertsin2011andrevisitedbyItalianandFrenchauthoritiesin2021:theone-offmutualizationofsomeEuropeanlegacydebtthroughthecreationofaEuropeanDebtManagementAgency(EDMA).Thepaperdoesnotargueinfavororagainsttheseproposalsormakeaproposalofitsown.RatheritoutlinesaconceptualframeworkthatcanbeusedtoquantifythecontoursofmutualizationproposalsanddrawslessonsfromthedebtassumptionintheUnitedStatesin1790.TheframeworksuggeststhatbycapitalizingtheconvenienceyieldonEuropean-widesafeassets,theEDMAcouldissueupto15percentofeuroareaGDP,helpingtoputnationaldebtsonasoundertrajectory.Theanalysissuggeststhat,withoutmutualization,someeuroareacountriesarelikelytoexperiencedecreasingdebt-to-GDPratiosovertheforecastperiod.ThisisnotthecaseforBelgium,Finland,France,Italy,andSpain,wherefurtherfiscalconsolidationwouldbeneeded.Forthesecountries,weconsidertheeffectsofadebtmutualizationequivalentto26percentoftheirGDP.ForItaly,thisoperationaloneisenoughtoensureadecreasingdebt-to-GDPpath.Fortheothers,thenewsismoremixed:whiletheadditionalfiscalconsolidationissmaller,1.3to2.3percentofGDParestillrequiredtoreducedebtwith95percentprobability. JELClassificationNumbers: E61,F34,F45,H63. Keywords: SovereignDebt;DebtMutualization;DebtAssumption;ConvenienceYield;SafeAssets. Author’sE-MailAddress: sando@imf.org,gdellariccia@imf.org,pgourinchas@imf.org,guido.lorenzoni@chicagobooth.edu,froch@imf.org *WethankCarlosAnguloforexcellentresearchassistance.TheviewsexpressedinthispaperarethoseoftheauthorsanddonotnecessarilyrepresentthoseoftheIMF,itsExecutiveBoard,oritsmanagement. WORKINGPAPERS DebtMutualizationintheEuroArea:AQuantitativeExploration PreparedbySakaiAndo,GiovanniDell’Ariccia,Pierre-OlivierGourinchas,GuidoLorenzoni,AdrianPeralta-AlvaandFranciscoRoch Introduction InresponsetotheCOVID-19crisis,bothadvancedandemergingmarketeconomieshaveimplementedlargefiscalstimulusprogramsthathavepushedpublicdebttohistoricallyhighlevels.Intheeuroarea,fiscalrulesweresuspended,andthelockdown-drivencontractionandassociatedpolicyresponseledsovereigndebttonewheights.Further,whilelargeincreasesindebt-to-GDPratioswerewidespread,thesewerenotsymmetric,withsomecountriessufferingmorethanothers.SomereliefonCOVIDrelateddebtshasbeenprovidedbyNextGenerationEU,butthesecountriesremaininanasymmetricsituation. Theswiftpost-COVIDrecoveryandsurpriseinflation,togetherwiththediscontinuationofseveralcostlycrisis-relatedmeasureshaveledtoastabilizationandinsomecasesreductionindebtratios.However,somecountries’debtremainsatalevelatwhichsustainabilitycanbequestionedinthefuture,leavingthempotentiallyexposedtoself-fulfillingruns.Thisisespeciallyrelevantsincerealinterestratesarerisingandlikelytoremainrelativelyhigherforsometime.Putdifferently,elevateddebtlevelsandhigherinterestratesmovedebtdynamicsinthe‘dangerzone’whereliquidityrunsaremorelikelyandcouldmorphintosolvencyproblems(Calvo,1988;LorenzoniandWerning,2019).Indeed,sovereignspreads,whileremainingwellbelowthelevelsexperiencedduringtheGFC,havestartedtoriseandbecomemorevolatile. Inpractice,centralbankshaveacriticalroletoplaytopreventliquidityrunsondomesticdebtviatemporaryinterventions—preferably‘offtheequilibriumpath,’coupledwithastronginstitutionalsettingthatenshrinesmonetaryindependenceandpreventsfiscaldominance.Intheeuroarea,theECBprovidesthissafetynet,whichiscriticaltoensuresmoothtransmissionofmonetaryimpulsesandpreventfinancialfragmentation. Suchataskishardertoimplementwhenasinglemonetaryauthorityisfacingtwentynationalfiscalauthoritiesasisthecaseintheeuroarea.Yet,sinceMarioDraghi’s“whateverittakes”announcementin2012,theECBhasbeenremarkablysuccessfulinpreventingfragmentation,includingduringtheCOVID-19pandemic.ThecurrentenvironmentofhighinflationmaycastdoubtsabouttheECB’sabilitytocontinuepreventingfragmentation.Inalowinflationenvironment,aloosepolicystanceconsistentwith“whateverittakes”wasalsothebestconjuncturalresponsetomaintainpricestability.Today,thetwoobjectives—pricestabilityandanti-fragmentation—mayr