COVID-19: the stabilising impact of EU bond issuance on sovereigns and banks.

This section explores the effects of the large-scale EU bond issuance and the ECB asset purchases in the context of a hypothetical financial crisis that would have been induced by the COVID-19 downturn. Stylised simulations show that the crisis response policies of the EU have strongly mitigated the risks associated with sovereign-bank loops in euro area countries. In particular, monetary policy action together with the introduction of a common debt instrument can more than halve potential losses to public finances from a hypothetical banking crisis. Moreover, these positive effects accrue to all Member States, even after accounting for costs linked to the extension of joint guarantees. The results also suggest that a recovery package offering a mix of both loans and grants to affected countries can be optimal for the euro area as a whole from the perspective of attenuating sovereign-bank loops.