This paper follows up on a CEPS Policy Insight of October 2020, in which Stefano Micossi argued that the increase in sovereign indebtedness under way in the euro area should be managed through collective policy actions. A repetition of austerity policies of the early 2010s is not consistent with maintaining adequate growth and sovereign debt sustainability in the post-pandemic environment. Likewise, a debt restructuring process with deep haircuts during this period will just upset the fragile state of the markets and create a run on the debt of the most vulnerable member states, forcing the ECB to buy even more debt.

Common policies are thus required to keep the sovereigns acquired by the ECB with its Asset Purchase Programme (APP) and Pandemic Emergency Purchase Programme (PEPP) programmes out of financial markets for an indefinite period. The European Stability Mechanism (ESM) can offer the appropriate instrument by purchasing the ECB-held sovereign debt and issuing own liabilities to fund the purchases. The programme could develop gradually over several years to ensure the smooth rollover of expiring securities. As the purchases would be funded by the ESM’s own liabilities backed by the sovereign holdings, ESM debt would become the long- sought-after European safe asset.

We argue that this ESM action could be conducted without an ESM Treaty change. It would be premised on the legal framework of the revised Article 14 (precautionary financial assistance). The ESM could then gradually evolve into a debt management agency for the euro area. The transfer of much of ECB sovereign holdings to the ESM would restore monetary policy independence and ease any frictions in this field, thereby allowing EU policymakers’ focus to shift to the completion of the European Banking Union.

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