Don’t look only to Brussels to increase the supply of safe assets in the European Union

A sufficient supply of safe assets denominated in euros is critical if the European Union is to achieve a full banking and capital markets union.

Executive summary

A sufficient supply of safe assets denominated in euros is critical if the European Union is to achieve full banking and capital markets union while fostering the euro’s international role. The European debate on developing the supply of safe assets has so far focused on the possible creation of a common safe asset. This has tended to underplay the potential contribution of sovereign assets. Expanding the supply of national safe assets, notably through the gradual implementation of fiscal and growth-oriented structural policies in euro-area countries, leading to upgrading of their sovereign ratings, provides a promising, and perhaps more feasible, option. An upgrade to triple A of those euro–area countries that are currently rated double A could produce substantially more safe assets than most common safe asset proposals, including those based on the development of ‘synthetic’ safe assets.

There has been a remarkable increase in the share of supranational assets in the stock of euro-based safe assets since 2008, reflecting downgrades in sovereign ratings and the EU’s financial responses to the euro–area crisis and the pandemic. However, safe assets in euro remain dominated by those issued by euro–area governments.

Although common safe assets have certain advantages over national safe assets, reflecting their built-in risk diversification properties, there is currently not much political appetite for such proposals. Meanwhile, sovereign safe assets already offer many of the advantages of common safe assets.

Sound fiscal policies and growth-stimulating reforms, which are in any case desirable, should be implemented to improve the credit ratings of euro–area sovereigns. This might not be politically feasible in the short-term, given the difficult economic environment currently faced by the EU, but it should be a key component of the EU’s medium-term safe asset strategy. Should the political consensus be found to create a common safe asset, such an asset could be incorporated into the euro area’s existing safe asset system, reinforcing its positive effects.

^{The views expressed in this document are solely those of the authors. The authors thank Annika Eriksgaard and Jeromin Zettelmeyer for their valuable comments}

1 Introduction

Europe’s Economic and Monetary Union (EMU) is still in development, meaning it is not perfect yet. One important issue on which further work is needed is ensuring an adequate supply of safe financial assets denominated in euros. This is critical for three important undertakings: completing the banking union, furthering the capital markets union, and strengthening the international role of the euro.

The European debate on developing the supply of safe assets, eg of high credit-quality bonds (typically those enjoying a triple A or just below credit rating), has so far focused on the possible creation of a new common safe asset. This focus has tended to underplay the potential contribution of sovereign safe assets ¹ . We argue that expanding the supply of national safe assets, notably through the gradual implementation of fiscal and growth-oriented structural policies leading to the upgrade of euro–area sovereign ratings, provides a promising and perhaps more feasible avenue to increase the supply of European safe assets. We show, in particular, how upgrading to triple A those EU countries that are currently rated double A could produce substantially more safe assets than most proposals aimed at creating a new a European common safe asset, including those based on the development of ‘synthetic’ safe assets. In the current European and global economic context, with debt ratios at historically high levels, interest rates rising sharply and economies drifting towards recession or stagnation, this might sound like wishful thinking. But we argue that there is a realistic path for many countries currently rated double A to reach triple A status over the medium term, if appropriate strategies are put in place.

We discuss first why an adequate supply of safe assets is critical for completing EMU. We then quantify the current supply of euro-denominated safe assets. This quantification distinguishes between safe assets issued by euro–area countries and those issued by EU supranational institutions. We then outline a possible strategy to increase the supply of safe assets in the EU, focusing on the relative contributions that national and supranational/common assets could make, while acknowledging that the two are not perfect substitutes, even when they share the same creditworthiness.

About the authors:

• Francesco Papadia

  Francesco Papadia is the chair of the Selection Panel of the Hellenic Financial Stability Fund (HFSF). He was, between 1998 and 2012, Director General for Market Operations at the European Central Bank. He worked previously at the Banca d´Italia, first as Director of the International Section of the Research Department and then as deputy head of the Foreign Department. Mr. Papadia has a degree in law from the University of Rome and attended postgraduate studies in Economics and Business at the Istituto Adriano Olivetti in Ancona and at the London Business School.

  Mr. Papadia is the author of a number of publications in the fields of International Economics and Monetary Policy. While collaborating with Bruegel, the focus of his research will be on European and global macroeconomic issues, including governance questions.

• Heliodoro Temprano Arroyo

  Heliodoro Temprano Arroyo is Adviser for International Economic Relations and Global Governance at the European Commission’s Directorate General for Economic and Financial Affairs (DG ECFIN). He previously headed the “Neighbourhood Countries and Macro-Financial Assistance” Unit in the same department, which managed the first large macro-financial support operations for Ukraine in the years following the Russian annexation of Crimea.

  During his career at the Commission, he has also headed the Units in DG ECFIN dealing with IMF matters, the finance track of the G20 and the G7, and globalisation and development issues. In 2007-2008, he coordinated the international chapters of the Commission’s EMU@10 report. He has also worked at the European I Department of the IMF and occupied senior positions at the Research Department of Banesto, a major Spanish bank. Between 2017 and 2018, he was a Fellow at the Robert Schuman Center for Advanced Studies of the European University Institute, where he conducted research on the financial and economic aspects of the EU’s external migration and refuge policy.

  A Spanish national, Mr. Temprano has published in the fields of international economics, regional monetary integration, transition economics and migration issues. He is the author of “The EU’s Response to the COVID-19 Crisis: A Game Changer for the International Role of the Euro?” (European Commission, June 2022).