Managing Deep Debt Crises in the Euro Area: Towards a Feasible Regime

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In spite of the inclusion of collective action clauses (‘euro‐CACs’) in euro area sovereign bond contracts since 2013, the euro area still does not have a credible debt restructuring framework because: (1) stability risks of debt restructurings remain high; (2) euro‐CACs make it easy for creditors to hold out for full repayment; (3) IMF lending policies have not prevented the bail‐out of countries with unsustainable debts. In reaction, some proposals have called for hard criteria requiring debt restructuring as a condition for access to official crisis lending. This paper argues that this is the wrong approach, because hard criteria are error‐prone, may trigger crises in high‐debt countries, and lack credibility when the economic costs of debt restructurings are high. Instead, the key to a credible debt restructuring framework is to reduce these costs, by cutting the links between sovereigns and banks and putting safety nets in place that limit contagion.