Working Paper: CEPR ID: DP9244
Authors: Roel Beetsma; Konstantinos Mavromatis
Abstract: We analyse different forms of international debt mutualisation in a simple framework with a political distortion and (partial) default under adverse economic circumstances. One form is a debt repayment guarantee, which can be "unlimited" or "limited", i.e. only be invoked when the guarantee threshold is not exceeded. We also explore the "blue-red" bonds proposal, under which blue debt is guaranteed by the other countries in a union, while red debt is not guaranteed. Only a suitably chosen limited guarantee induces the government to reduce debt and raises social welfare. Making the guarantee also conditional on sufficient structural reform may stimulate reform effort. However, now a trade-off exists between extracting more reform and inducing the government to limit debt issuance.
Keywords: blue and red bonds; debt bias; debt guarantee; eurobonds; political distortions; social welfare; structural reform
JEL Codes: E60; E62; H60; H63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| limited debt guarantee (H81) | reduce debt levels (H63) |
| reduce debt levels (H63) | raise social welfare (I39) |
| unlimited debt guarantee (H81) | increase debt levels (H63) |
| limited debt guarantee (H81) | create incentives for structural reforms (E69) |
| create incentives for structural reforms (E69) | enhance social welfare (I30) |