Restoring Financial Stability in the Euro Area
CEPS Policy Brief No. 237
26 Pages Posted: 2 Apr 2011 Last revised: 5 Apr 2011
Date Written: March 15, 2011
Abstract
Several proposals have been made on how sovereign risk premia in the euro area should be brought down, namely i) permanent pooling of funding through joint bond issuance, ii) temporary liquidity assistance through multilateral funds, iii) debt buybacks using multilateral funds, and iv) debt restructuring. This paper evaluates these four proposal. It argues that joint bond issuance will not achieve a meaningful reduction of average borrowing rates. There needs to be an institution to provide temporary liquidity assistance instead. Debt buybacks at market prices can be a very useful tool for solvent countries such as Spain, but they would not allow to correct Greece’s debt overhang. In the case of Greece, an exchange of existing government bonds at below-market prices could restore sovereign creditworthiness and allow the private sector to regain market access at acceptable interest rates.
Keywords: pricing, sovereign credit, credit, risk, financial, European Monetary Union, government, bonds, intermediation, economic recovery, funds, debt
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