Working Paper: CEPR ID: DP9976
Authors: Marcus Miller; Lei Zhang
Abstract: European markets for sovereign bonds have been prone to panic as investors fly to safety whenever they think others will. Calvo (1988) had warned of the possibility of multiple equilibria in bond markets; and argued for official action to limit interest rate rises so as rule out a self-fulfilling default equilibrium. Until recently, however, it appeared that the ECB was not able to act as necessary. But in August 2012, the ECB announced a policy of Outright Monetary Transactions which promised intervention to put a ceiling on rates for sovereigns willing to accept further fiscal stringency; and we use Calvo?s framework to illustrate how this policy of a ?put? for sovereigns can work.In addition to unilateral action by the ECB, some have proposed the consolidation of sovereign debt into Eurobonds backed by a supranational agency. Specifically, we propose the creation of a Special Purpose Vehicle (SPV) which issues Eurobonds and holds both plain vanilla sovereign debt and newly created state-contingent bonds. This offers, we believe, a desirable complement to the ?Draghi put?.
Keywords: Creditor panic; Debt consolidation; Sovereign illiquidity; Sovereign insolvency
JEL Codes: F34; F42
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| ECB's OMT policy (E52) | reduction in sovereign spreads for Italy and Spain (H68) |
| ECB's OMT policy (E52) | stabilization of market expectations (E63) |
| ECB's OMT policy (E52) | reduced perceived default risk (G32) |
| OMT policy (F13) | prevention of bad equilibrium (high interest rates and fears of default) (E44) |
| Creation of SPVs for eurobonds (G12) | improved market conditions (R31) |
| Institutional innovations (O35) | better outcomes in debt sustainability and economic growth (H63) |