Too much of a good thing? Safe assets, spillovers, and fiscal policy coordination

Title: Too much of a good thing? Safe assets, spillovers, and fiscal policy coordination

Summary: This paper studies the incentives and interactions of multiple safe asset issuers and identifies when a lack of fiscal coordination can lead to an excessive supply of safe assets

Authors: Matthieu Bellon (IMF), Matthias Gnewuch (ESM), Jacopo Orlandi (Bank of Italy), Luca Zavalloni (ESM)

Abstract: Are public debt levels too high and convenience yields too low, or is the opposite true? Safe asset issuers have market power, which incentivises them to restrict issuance to raise the convenience yield earned on foreign-held debt. Yet, these governments also tend to over-issue, failing to internalise the fiscal cost they impose abroad by lowering demand for other countries’ bonds and, thus, their convenience yields. We develop a model of financially integrated economies and show analytically that the relative strength of these opposing incentives depends on public expenditure (which exacerbates the fiscal externality) and bond substitutability (which reduces governments’ bond market power). Calibrating the model to the euro area over the period 2015-2023, we find the fiscal externality to dominate: non-cooperative governments that ignore spillovers issue too much debt, on the order of 5% of GDP, compared to a cooperative benchmark. Introducing common debt mitigates the market power distortion, but exacerbates the fiscal externality and can thus improve the non-cooperative equilibrium when market power is the dominant distortion.

Non-technical summary

Disclaimer: This Working Paper should not be reported as representing the views of the ESM. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the ESM or ESM policy. No responsibility or liability is accepted by the ESM in relation to the accuracy or completeness of the information, including any data sets, presented in this Working Paper.

Keywords: Convenience Yield; Sovereign Debt; Fiscal Spillovers; Fiscal Policy Coordination; Safe Assets; EMU

JEL codes: E62; H63; F36; E44

Source: European Stability Mechanism | Working Paper Series | Volume 2026 | No. 78 | July 2026 | 62 Pages
 

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