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.
This paper puts forward a proposal to complete the ECB Transmission Protection Instrument (TPI) with the aim of making it more effective in anchoring the yields of European sovereign debts to Member States’ fundamentals. We use a model in which yields fluctuate within bands, which we specify following two alternative approaches: stochastic and deterministic. The resulting fluctuation's interval represents the range of yields that can be seen as justified by Member States’ fundamentals; yields outside the band would instead trigger the ECB intervention as foreseen by the TPI. The proposal minimizes the risk of moral hazard, as the fluctuation bands vary as each country's creditworthiness changes. Moreover, the proposal is directly implementable with existing Treaties.
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