Working paper

State contingent debt as insurance for euro-area sovereigns

Since the financial crisis, EU countries' economies have recovered to the point that they are exiting their adjustment programmes. Institutional stabi

Publishing date
26 April 2018

The euro-area sovereign debt crisis is receding. Europe is on a recovery path, growth is broad-based and unemployment is falling. One after the other, countries hit hardest by the crisis are exiting their adjustment programmes. However, debt remains high in most countries and future debt crises should not be ruled out. While the memories are fresh, it is a good time to think about insurance against future shocks. Such insurance schemes must involve risk sharing with the markets. They weaken the bank-sovereign doom loop from the sovereigns’ side, and not just from the banks’ side as pursued by the banking union, and make for a more resilient euro area.

The promotion of the banking union and the establishment of a European Monetary Fund are institution-based solutions to crises. Banking union provides the safety regulations that will make banking institutions more resilient, while the EMF is a ‘fire brigade’ to be called on in emergencies. What has not been tapped are the markets, whose tolerant behaviour to sovereign demands encouraged the built up of debt, while their finicky response exacerbated the crisis.

Taking ongoing G20 discussions on sovereign contingent debt as the point of departure, the authors argue that these instruments could provide market-based insurance to protect the euro area from future debt crises. Risk-sharing with the markets is a constructive way forward in the context of the Franco-German debate on risk-sharing among states versus system-wide risk reduction. The financial innovation of contingent debt is a practical euro-area reform that would not introduce risk-sharing between states or require institutional reforms or Treaty changes. However, coordination would be needed.

About the authors

  • Maria Demertzis

    Maria Demertzis is the interim Director at Bruegel. She has previously worked at the European Commission and the research department of the Dutch Central Bank. She has also held academic positions at the Harvard Kennedy School of Government in the USA and the University of Strathclyde in the UK, from where she holds a PhD in economics. She has published extensively in international academic journals and contributed regular policy inputs to both the European Commission's and the Dutch Central Bank's policy outlets.

  • Stavros Zenios

    Stavros Zenios is a Cypriot citizen with a long career in the USA. His current research focuses on sovereign debt issues. He is working on the development of stochastic dynamic models for debt sustainability analysis and risk management for sovereigns, on sovereign contingent debt such as GDP-linked bonds and sovereign coco’s, and on disentangling the impact of economic policy and political stability risks. He regularly appears on National media discussing issue relating to the Cyprus crisis, transparency and corruption, and consulted by the international press on Eurozone crisis issues. During 2013-2014 he was Vice chairman of the Cyprus Council of Economic Advisors and served on the Board of the Central Bank of Cyprus (2014-2015).  He served two terms as President of UNICA-Universities of European Capitals (2004-2012) and two terms as Rector of University of Cyprus (2002-2010).

    He is a professor of finance and management science at University of Cyprus, Adjust professor at the Norwegian School of Economics and Senior Fellow at the Wharton School, USA.

    He received a PhD in engineering management systems from Princeton University. He also studied mathematics at University of London and electrical engineering with the Higher Technical Institute in Cyprus.

    He published more than 150 scholarly articles in some of the leading journals in the fields of finance, management science and operations research. He authored five books and edited seven with Cambridge University Press, Blackwell and Wiley Finance. He co-authored with Yair Censor the award-winning book "Parallel Optimization", Oxford University Press. His book with Patrick Harker on "Performance of Financial Institutions" was translated in Chinese.

Related content