- Making Sovereign Debt Safe with a Financial Stability Fund“ (with Yan Liu and Adrien Wicht), September 2023.
We develop an optimal design of a Financial Stability Fund that coexists with the international debt market. The sovereign can borrow defaultable bonds on the private international market, while having with the Fund a long-term contingent contract subject to limited enforcement constraints. The Fund contract does not have ex ante conditionality, but requires an accurate country-specific risk-assessment (DSA), accounting for the Fund contract. The Fund periodically announces the level of liabilities the country can sustain to achieve the constrained-efficient allocation. The Fund is only required minimal absorption of the sovereign debt, but it must provide insurance (Arrow-securities) to the country. Furthermore, with the Fund all sovereign debt is safe independently of the seniority structure; however, seniority of the Fund, with respect to the private lenders, may require a greater minimal absorption than a pari passu regime. We calibrate our model to the Italian economy and show it would have had a more efficient path of debt accumulation with the Fund.
- “Harvesting official lending conditions“ (with Daragh Clancy, Aitor Erce and Andreja Lenarcic), December 2022.
Countries must comply with loan conditions in order to receive official-sector financial support. After constructing a unique dataset with condition-level information for euro area financial assistance programmes, we demonstrate the importance of creditors’ discretion on the timing and content of assessments in boosting compliance with conditionality: by choosing to assess a relatively small number of conditions and by delaying the assessments of others until conditions could be fulfilled. As a result, compliance with a relatively small subset of conditions is sufficient to satisfy creditors and trigger disbursements, especially fiscal measures aimed at the immediate stabilisation of public finances and those with explicit numerical targets, with structural conditions playing a minor role.
- “On the optimal design of a Financial Stability Fund“ (with Arpad Abraham, Eva Carceles-Poveda and Yan Liu) July, 2022.
We develop a model of a Financial Stability Fund (Fund) for a union of sovereign countries. By contract design, the Fund never has expected undesired losses while, being default-free, a participant country has greater ability to borrow and share risks than using sovereign debt financing. The Fund contract also provides better incentives for the country to reduce endogenous risks. These efficiency gains arise from the ability of the Fund to offer long-term contingent financial contracts, subject to limited enforcement (LE) and moral hazard (MH) constraints as part of the contingencies.
- “Fiscal and Currency Union with Default and Exit” (with Alessandro Ferrari and Chima Simpson-Bell), April 2021.
We study the optimal designs of a Fiscal Union with independent currencies and of a Monetary and Fiscal Union (Currency Union) and their relative performance. We derive the optimal fiscal-transfer policy in these unions as a dynamic contract subject to enforcement constraints, whereby in a Currency Union each country has the option to unpeg from the common currency, with or without default on existing obligations. Our analysis shows that the lack of independent monetary policy, or an equivalent independent policy instrument, limits the extent of risk-sharing within a Currency Union. It also shows that the optimal state-contingent transfer policy implements a constrained efficient allocation that minimises the losses of the monetary union; that is, the fiscal transfer policy is complementary to monetary policy.