When Fiscal Discipline meets Macroeconomic Stability: the Euro-stability Bond

We describe a new Euro-stability bond that implies sovereign debt mutualization in the Eurozone without any significant short-term redistribution across countries or perverse incentives to fiscal profligacy. In a simple structural model of the economy, we theoretically show that the proposed Euro-stability bond is able to reproduce the market fiscal discipline while increasing the social welfare of all countries with respect to real market discipline. Relying on a GVAR model including the Eurozone countries, the U.S., Japan and China, we then analyze the future evolution of public debt (and other key macroeconomic variables) over time by comparing the predicted forecast in the baseline scenario and in a counterfactual scenario with the Euro-stability bond. We find no significant differences in the future path of interest expenditures and public debt-to-GDP ratios in the two scenarios, but a consistent reduction in the uncertainty of the estimates in the counterfactual scenario (around 68 % on average after 5 years). The reduced uncertainty of forecasts of public debt and other macroeconomic variables highlights the capacity of the Euro-stability bond to immunize the Eurozone from classical macroeconomic instability shocks that derive by the very existence of high sovereign debts and the related significant rollover risk in a framework of decentralized fiscal policies. To this extent, we finally exploit the results of the GVAR model to assess the capacity of the proposed scheme to reduce the probability of adverse macroeconomic events.