On a lender of last resort with a central bank and a stability fund

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• dc.contributor.author Callegari, Giovanni
• dc.contributor.author Marimon, Ramon
• dc.contributor.author Wicht, Adrien
• dc.contributor.author Zavalloni, Luca
• dc.date.accessioned 2024-02-23T07:44:24Z
• dc.date.available 2024-02-23T07:44:24Z
• dc.date.issued 2023
• dc.description.abstract We explore the complementarity between a central bank and a financial stability Fund in stabilizing sovereign debt markets. The central bank pursuing its mandate can intervene with public sector purchasing programs, buying sovereign debt in the secondary market, provided that the debt is safe. The sovereign sells its debt to private lenders, through market auctions. Furthermore, it has access to a long-term state-contingent contract with a Fund: a country-specific debt-and-insurance contract that accounts for no-default and no-over-lending constraints. The Fund needs to guarantee gross-financial-needs and no-over-lending. We show that these constraints endogenously determine the ‘optimal debt maturity’ structure that minimizes the Required Fund Capacity (RFC) to make all sovereign debt safe. However, the Fund may have limited absorption capacity and fall short of its RFC. The central bank may be able to cover the difference, in which case there is perfect complementarity and the joint institutions act as an effective ‘lender of last resort’. We calibrate our model to the Italian economy and find that with a Fund contract its ‘optimal debt maturity’ is 2.9 years with an RFC of 90% of GDP, which is above what the European Stability Mechanism (ESM) could reasonably absorb, but may be feasible with an ECB Transmission Protection Instrument (TPI) intervention. In contrast, the average maturity of Italian sovereign debt has been circa 6.2 years, with a needed absorption capacity of around 105% of GDP, which may call for a maturity restructuring to ease the activation of TPI.
• dc.format.mimetype application/pdf
• dc.identifier.citation Callegari G, Marimon R, Wicht A, Zavalloni L. On a lender of last resort with a central bank and a stability fund. Rev Econ Dyn. 2023;50:106-30. DOI: 10.1016/j.red.2023.07.012
• dc.identifier.doi http://dx.doi.org/10.1016/j.red.2023.07.012
• dc.identifier.issn 1094-2025
• dc.identifier.uri http://hdl.handle.net/10230/59232
• dc.language.iso eng
• dc.publisher Elsevier
• dc.relation.ispartof Review of Economic Dynamics. 2023;50:106-30.
• dc.rights © 2023 The Author(s). Published by Elsevier Inc. This is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/).
• dc.rights.accessRights info:eu-repo/semantics/openAccess
• dc.rights.uri https://creativecommons.org/licenses/by-nc-nd/4.0/
• dc.subject.keyword Recursive contracts
• dc.subject.keyword Limited enforcement
• dc.subject.keyword Debt
• dc.subject.keyword Self-fulfilling beliefs
• dc.title On a lender of last resort with a central bank and a stability fund
• dc.type info:eu-repo/semantics/article
• dc.type.version info:eu-repo/semantics/publishedVersion