Managing Deep Debt Crises in the Euro Area: Towards a Feasible Regime
Paper for Special Issue of Global Policy "Ten Years Since The Global Financial Crisis: Lessons Learned, Opportunities Missed"
In spite of the inclusion of collective action clauses ("euro-CACs") in euro area sovereign bond contracts since 2013, the euro area still does not have a credible debt restructuring framework because (1) stability risks of debt restructurings remain high; (2) euro-CACs make it easy for creditors to hold out for full repayment; (3) IMF lending policies have not prevented the bailout of countries with unsustainable debts. In reaction, some proposals have called for hard criteria requiring debt restructuring as a condition for access to official crisis lending. This paper argues that this is the wrong approach, because hard criteria are error-prone, may trigger crises in high-debt countries, and lack credibility when the economic costs of debt restructurings are high. Instead, the key to a credible debt restructuring framework is to reduce these costs, by cutting the links between sovereigns and banks and putting safety nets in place that limit contagion.