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Sovereign Debt Management in the Euro Area as a Common Action Problem

This Policy Insight discusses sovereign debt management in the euro area, where the COVID-19 crisis has caused a huge increase in such debts. Our two main conclusions are that sovereign debt externalities remain important in the euro area, even in the new environment of permanently lowered interest rates, and that these externalities justify common euro area policies to deal with excessive sovereign debt accumulation and the attendant risks to the euro area’s financial stability. Our proposal is that a substantial part of the sovereigns purchased by the European System of Central Banks (ESBC) – in the order of 20% of euro area GDP – could gradually be transferred to the European Stability Mechanism (ESM), without any transfer of default risks, which would continue to fall on national central banks.