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Orderly debt reduction rather than permanent mutualisation is the way to go

Vihriälä, V. & Weder di Mauro, B. (2014) “Orderly debt reduction rather than permanent mutualisation is the way to go“, VoxEU Organisation, 02 April.

 

The EZ debt overhang needs to be fixed. This column argues that making market discipline credible requires an orderly debt restructuring mechanism combined with a strictly regulated temporary mutualisation scheme or a well-designed debt conversion scheme. This combination could reduce the current debt overhang in an orderly fashion and cement strong incentives against over-borrowing in the future.

High levels of public debt have been at the centre of the euro crisis. Perceived unsustainability of individual member states’ public debt resulted in high interest rates and the threat of exclusion from the bond market. This prompted emergency financial assistance, the establishment of institutions for assistance, and ultimately the Outright Monetary Transactions (OMT) promise by the ECB. The effective partial mutualisation of sovereign risk has been important in calming down market turbulence and allowing a modest recovery to take hold.

 

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