One of the legacies of the global financial crisis is a high ratio of public debt to GDP. While current levels may be sustainable, another series of bad shocks could easily tip the balance and lead to unsustainable debt ratios and to default. The quantitative exercises presented in this Policy Brief show that growth-indexed bonds can play an important role in that context. By decreasing payments when growth is low, they can substantially reduce the "tail risks" associated with explosive debt paths starting from today's high ratios. The introduction of growth-indexed bonds will benefit highly indebted advanced economies and, in the euro area, might provide a partial market-based solution to attain valuable insurance benefits well ahead of a formal fiscal union.
The data underlying the figures in this analysis are available here.