Making sovereign debt safe and sustainable in the EU

Abstract:

An overview of part of my reseach agenda On the Design of a Financial Stability Fund. Starting from the fundamental design of a Fund that can absorb the Soverign Defaultable Debt of a country and transform it in a long-term state-contingent safe asset, making the debt sustainable (default free) and providing risk-sharing and smooth consumption to the country, while preventing the Fund from having expected losses, which in the context of a union means preventing mutualization (with Ábraham, Cárceles-Poveda & Liu, REStud 2025). Second, showing that the same constrained-efficient allocation can be achieved with most of the Sovereign Debt in the private debt market, as long as the Fund has a minimal Required Absorbing Capacity (RCA; with Liu & Wicht, JIE 2023). Third, allowing the Central Bank to back the Fund to achieve the RCA while, by making the sovereign debt safe, the Fund allows the CB to intervene in the private debt market. The joint institutions act as an effective ‘lender of last resort’ (with Callegari, Wicht and Zavalloni, RED 2023) Finalising the overview with how the Fund can make a Fiscal Rule (FR, such as SGP) credible (self-enforcing) and more efficient, although having the FR as an additional constraint changes the fundamental dynamics of the Fund. All quantitative results are based on calibrations to euro area countries. Finally, time permitting, I will refer to two further outcomes of this agenda: first, on the design and implementation of an independent European Stability Fund and, second, on two new theories: “A Theory of Conditionality: Evidence from the European debt crisis” (with Lenaric, Erce and Clancy) and A General Theory of Moral Hazard: static and dynamic (in “Risk Sharing and Risk Reduction with Moral Hazard”, with Wicht and Zavalloni).