This lecture develops the theory behind the proposal of a European Stability Fund as a optimal Financial Stability Fund subject to limited enforcement (non-default and no-permanent-transfers) and, possibly, moral hazard constraints. It is based on a trilogy of papers*: (ACLM) develops the basic theory with a Fund that absorbs all the debt of a sovereign country and accounts for moral hazard constraints; (LMW) shows how a Fund with a minimal intervention in sovereign debt market with private lenders can make all the debt safe, provided that it has sufficient absorbing capacity, and (MWZ) takes into account that the Fund may have limited absorbing capacity. Nevertheless, in conjunction with a Central Bank, which can absorb sovereign debt if -- and only if -- it is safe, they can together act as a Lender of Last Resort. In all of them, we calibrate our models to euro area 'stressed' countries, showing how these countries would have been better off with a well-designed Fund and sovereign debt would have been safe (a large supply of 'safe assets') without any debt mutualisation.
"On the optimal design of a Financial Stability Fund" (with Arpad Abraham, Eva Carceles-Poveda and Yan Liu) July, 2022. (ACLM)*
"Making Sovereign Debt Safe with a Financial Stability Fund" (with Yan Liu and Adrien Wicht), September 2023. (LMW)
"On a Lender of Last Resort with a Central Bank and a Stability Fund" (Callegari, Wicht and Zavalloni), Forthcoming 2023, RED. (MWZ)