Dealing with Legacy Debt in the Euro Area

Regardless of the direction they choose, however, current high levels of public debt and large differences between member states in this respect may constitute an obstacle to implementation. They make it difficult to reconcile national positions on the future of the euro area and are one of the reasons discussions are so difficult to advance.

True, the high levels of public debt can still be corrected by sustained budgetary adjustment. This strategy is nevertheless not without risk. It will only bear fruit in fifteen or twenty years, leaving highly indebted countries in a state of vulnerability should an economic shock occur on the path to adjustment. If a large member state were to default, for example, the consequences for the area would be disproportionately high. Lastly, because lower levels of public debt are one of the preconditions for a coherent, stable and sustainable architecture for the euro area, there is a risk the completion of the reforms that would make this possible will be postponed indefinitely.

The current strategy of budgetary adjustment should be pursued, but other possible ways of addressing the problem of high levels of public debt should also be explored, should unforeseen events in the future call for quicker remedies. This is a difficult exercise and requires some unconventional thinking. In this note, we suggest three non-mutually exclusive avenues of resolving this predicament.

In the first, countries would jointly commit to supporting a member state engaged in a process of budgetary adjustment in the event of lower-than-expected economic growth. Solidarity would be limited and conditional on reform and budgetary adjustment but would nevertheless contribute to joint “ownership” of national efforts. It would also strengthen the credibility of the budgetary adjustment paths.

While public debt has increased over the past twenty years, so has household wealth – particularly when it comes to real-estate – with large distributional consequences. A second avenue could therefore consist of a highly indebted country decreeing that it becomes part-owner of all lands on which dwellings are built, up to a given fraction of their value (establishing a leasehold in effect on part of the land). The payment for the right of occupancy by the homeowner would generate an annual revenue stream for the state. Homeowners could chose to differ annual payments, the total amount of which would become due only upon the sale or inheritance of the home.

A third and final solution would be to rely on the European Central Bank. It could repurchase part of highly indebted countries’ sovereign debt, exchanging them into perpetual non-interest bearing bonds and keeping them on its balance sheet.

These three proposals are inevitably novel and radical in nature, and some may even consider them dangerous. They raise obvious political and legal challenges. The debate should nevertheless be tackled head-on to avoid hasty and unprepared decisions should another large-scale crisis hit the euro area in the future.

La Note d’analyse is published under the editorial responsibility of France Stratégie's Commissioner-General.

The opinions expressed are those of the authors and do not reflect in any way the position of the government.