Debt Mutualization in the Euro Area: A Quantitative Exploration

IMF Working Papers, March 17, 2023

Source details

Canonical URL: Debt Mutualization in the Euro Area: A Quantitative Exploration

Authors: Sakai Ando, Giovanni Dell'Ariccia, Pierre-Olivier Gourinchas, Guido Lorenzoni, Francisco Roch
Published: March 17, 2023
Series: IMF Working Papers
DOI: https://doi.org/10.5089/9798400234309.001

Explores feasibility of a one-off mutualization of some European legacy debt via a European Debt Management Agency (EDMA), an idea first proposed in 2011 and revisited in 2021.
Provides a conceptual framework to quantify contours of mutualization proposals and draws lessons from the United States debt assumption in 1790.
Does not advocate for or against mutualization nor propose a specific policy; offers a quantitative exploration tool.

By capitalizing the convenience yield on European-wide safe assets, the EDMA could issue up to 15 percent of euro area GDP.
Analysis indicates that, without mutualization, some euro area countries are likely to experience decreasing debt-to-GDP ratios over the forecast period; exceptions include Belgium, Finland, France, Italy, and Spain.
For Belgium, Finland, France, Italy, and Spain, the paper models a debt mutualization equivalent to 26 percent of their GDP.
For Italy, a mutualization equivalent to 26 percent of GDP is sufficient alone to ensure a decreasing debt-to-GDP path.
For Belgium, Finland, France, and Spain, even after mutualization equivalent to 26 percent of GDP, additional fiscal consolidation of 1.3 to 2.3 percent of GDP is required to reduce debt with 95 percent probability.

Scenario: No mutualization — some countries see decreasing debt-to-GDP ratios naturally; Belgium, Finland, France, Italy, and Spain do not.
Scenario: Mutualization via EDMA up to 15 percent of euro area GDP — could improve national debt trajectories by capitalizing convenience yield.
Scenario: Country-level mutualization equivalent to 26 percent of GDP — yields country-specific outcomes, sufficient for Italy, partially effective for Belgium, Finland, France, and Spain but still requires additional consolidation between 1.3 and 2.3 percent of GDP to achieve debt reduction with 95 percent probability.

Mutualization can materially alter debt trajectories by leveraging demand for European-wide safe assets and the associated convenience yield.
The size of mutualization matters: euro-area-wide issuance up to 15 percent of GDP is a significant envelope; country-level mutualization calibrated to 26 percent of GDP has heterogeneous effects across countries.
For several high-debt countries, mutualization reduces but does not eliminate the need for fiscal consolidation; quantified additional consolidation needs are 1.3 to 2.3 percent of GDP for some countries to achieve high-probability debt reduction.
The framework can inform the design and sizing of mutualization proposals and clarify fiscal adjustment needs post-mutualization.

IMF Working Paper: "Debt Mutualization in the Euro Area: A Quantitative Exploration" (Working Paper No. 2023/059, March 17, 2023).