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Growth-linked anti-cyclical debt: A solution for Europe’s public debt overhangs
Journal of Risk Management in Financial Institutions,
8
(3),
277-288
(2015)
Abstract
European governments are overburdened with debt, yet Europe’s debt-centred financial markets lack a mechanism to efficiently reduce overhangs. In the private sector, household and corporate losses have left €1tn of non-performing loans on the balance sheets of banks, which have grown to 3.1 × GDP. In the public sector, despite the recent introduction of collective action clauses on sovereign bonds, the Greek example highlights still-limited flexibility to restructure sovereign debt. In this paper we analyse the impact of flexible debt that adjusts interest payments in line with growth performance: growth-linked anti-cyclical debt (GLAD). We model the economic impact of replacing nominal debt with growth-linked bonds for an economy subject to random external shocks as well as political cycles (eg pre-election excess spending). Our analysis shows GLAD bonds reduce the probability of austerity-debt spirals, by easing the burden of interest payments on economies hit by negative shocks, and smoothing cycles. GLAD bonds are naturally a more volatile instrument than normal fixed rate bonds, but they can be calibrated to give the same average payoff as a normal bond, ie compensating for the transfer of risk from creditors to debtors. In a currency union, where monetary policy is set based on the whole and therefore based mostly on large countries, GLAD bonds can provide an additional channel of flexibility for small countries.
Keywords: Greece; growth-linked bonds; European crisis; debt overhangs; debt sustainability
The full article is available to subscribers to the journal.
Author's Biography
Alberto Gallo heads Macro Credit Research at RBS. His team has been top-ranked by Institutional Investor in 2013, 2014 and 2015. Mr Gallo is active in the financial policy debate as a contributor to the ECB financial stability contact group (MFCG) and to the think tank Action Institute. Mr Gallo holds an MSc in economics cum laude from Bocconi University and is a chartered financial analyst. He previously served in the navy and was a national athletics champion.
Lee Tyrrell-Hendry is part of the macro credit research team at RBS, generating investment strategies and trade ideas across European credit markets, which received top rankings in the Institutional Investor Investment Grade and High Yield Strategy All-Europe Fixed Income Research awards. Lee co-writes The Revolver and The Silver Bullet, combining macro and micro analysis of sovereigns, banks and corporates. He graduated with a first class degree in economics from the University of York.
Mateja Popovic is member of the macro credit research team at RBS, generating investment strategies and trade ideas across European credit markets. He co-writes The Revolver and The Silver Bullet, which combines macro and micro analysis of European sovereigns, banks and corporates. He has previous financial market experience in macro rates distribution, with a focus on official institutions. Mateja holds a BSc in PPE from the University of Warwick.
Tao Pan works in the macro credit research team at RBS. The team generates investment strategies and trade ideas across sovereign, bank and corporate credit in Europe, the US and Emerging Markets, and received top 3 rankings in Institutional Investor’s All-Europe Fixed Income Survey in 2013, 2014 and 2015. She co-writes The Revolver and The Silver Bullet. Tao holds a BA (hons) in Land Economy from the University of Cambridge.
Ashleigh Grant is an analyst in the macro credit research team at RBS, generating investment strategies and trade ideas across European credit markets and co-writing publications The Silver Bullet and The Revolver. She has previous experience in debt capital markets with a focus on European corporates. Her previous roles include high yield syndicate, liability management and secured debt markets. Ashleigh holds a BA Honours in English from the University of Oxford.
Citation
Gallo, Alberto, Tyrrell-Hendry, Lee, Popovic, Mateja, Pan, Tao and Grant, Ashleigh (2015, July 1). Growth-linked anti-cyclical debt: A solution for Europe’s public debt overhangs. In the Journal of Risk Management in Financial Institutions, Volume 8, Issue 3. https://doi.org/10.69554/MHES1012.
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Publications LLP