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The design of a sovereign debt restructuring mechanism for the euro area: Choices and trade-offs

This paper critically assesses several dimensions of a sovereign debt restructuring mechanism (SDRM) for the euro area. The novelty of our analysis is that we abstain from recommending one ideal model for a restructuring mechanism. Instead, we apply a menu-type approach. For five key institutional SDRM dimensions, we discuss the underlying fundamental trade-offs and discuss the pros and cons of different design choices. Specifically, we investigate the following SDRM dimensions: (i) the institutional assignments of responsibilities, (ii) the condition or decision rule that triggers a debt restructuring, (iii) the design and size of debt restructuring, (iv) the role and details of collective action clauses (CACs), and (v) the safeguards for financial stability in support for a SDRM. We conclude that there is no such thing as the single optimal SDRM. Design decisions require judgements on the underlying trade-offs and related assumptions on relative costs. Also, the search for an appropriate euro area SDRM design can benefit from complementarities. Ambition in one dimension can offer more degrees of freedom in another dimension. Our analysis implies that there is no convincing reason to further taboo the search for a euro area SDRM, as there are ways to combine the opportunities of a credible SDRM with financial stability.