MAKING SOVEREIGN DEBT SAFE WITH A FINANCIAL STABILITY FUND (BY - - PowerPoint PPT Presentation

A DISCUSSION OF “MAKING SOVEREIGN DEBT SAFE WITH A FINANCIAL STABILITY FUND”

(BY LIU, MARIMON & WICHT)

Aitor Erce (UPNA)

My nutshell

The paper designs a co-insurance contract: ■ Use strict rules (DSA) and state-contingent contracts to ensure agents do the right thing ■ deliver default-free debt (more safe assets) ■ require no permanent transfers, nor seniority

Could a paper be more timely?

The setting

■ Seniority status and pari-passu – Default is selective despite pari-passu – If official debt is senior, dilution risk may trigger K flight ■ Total default – Default is always partial (acceleration not a given) ■ Sovereign debt perimeter – The setting by-passes the diabolic loop ■ DMO job is straight forward ( is exogenous) – Would ESF affect the maturity of market borrowing?

The meaning

■ Negative yields – Isn't this official debt relief? – Also PSI results in a reduction yields (resolution vs. default) ■ Arrow securities – Who does the ESF trade them with? – Dummies like me need this more eschewed: how can we replicate the payoffs in reality to deliver countercyclical debt? Can we use plain vanillas, puts and calls?

The elephant

Debt Sustainability Analysis

ESF-DSA makes an amazing job. Its main features are: – State-dependent – Considers spillovers (Z) – Strict and mechanical: must be met in every possible state ■ Is it replicable? – No room for systematic errors – No room for grey zones – No room for judgement and “exemptions” All of these can open the door to problems with DSA

DSA: Biases and incentives

■ Case-by-case approach requires the use of judgment on top of the mechanical DSA exercise ■ Judgement doesn't improve DSA accuracy – Political inference (Gelpern 2016)

DSA: Biases and incentives

■ The mechanical DSA modelling is weak (Corsetti 2019) – This makes judgement necessary (IMF 2019) ■ Can the same body simultaneously be accountable lender and impartial sustainability judge? – Lang & Presbitero (2018): bureaucratic interest affect DSA – Antic & Persico (2020): if an agent compensation is “too tied” to the assets she manages, she optimally weakness the quality of her signal/misreports

Opacity ty in DSA ■ Greece: Enhanced Surveillance Report (November 2019). EC ■ Greece: 2019 Article IV Consultation

■ Great effort on a critical area: contingent and countercyclical sovereign financing instruments and institutions are on high demand ■ I am looking forward to reading your future papers!!!