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Abstract

Countries with large debts stocks are vulnerable to the vagaries of the markets. Confidence crises can arise out of nowhere, constricting access to the markets. As of this writing in mid-2020, as a result of Covid-19, Italy risks such a crisis. A number of other euro area countries, hard hit by the novel coronavirus may soon reach that stage as well. The question arises as to whether euro area countries such as Italy should put in place mechanisms that will help them better prepare for the possibility of a severe debt crisis. In effect, the choice is whether to buy insurance. The cost of buying such insurance is that the possibility that markets will see the sovereign’s proactive steps to protect against a crisis not as an indication of prudent governance but rather as an indicator that a crisis is imminent. We use the case of Italy, which has a large debt stock and a known vulnerability to confidence crises to set forth the options a euro area country has in anticipation of a possible future debt restructuring. It can: do nothing; do a little; or do something substantial.

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