Safe government bonds enjoy a discount known as the convenience yield. When a government issues more debt, it erodes this discount for itself and for other countries – a fiscal externality that incentivises excessive debt issuance. But safe asset issuers also have market power, and thus incentives to reduce issuance to boost the convenience yield and extract rents from foreign bondholders. This column studies these distortions under non-cooperative fiscal policy. Over the past decade, the fiscal externality has dominated in the euro area, fostering over-issuance of safe sovereign debt. This calls for fiscal coordination and restraint even absent debt sustainability concerns.
Safe assets are essential for the functioning of modern economies. These assets – mainly sovereign bonds issued by highly rated countries – provide investors with a safe and liquid store of value, serve as collateral in financial transactions, and act as a safe haven during periods of financial stress (Reis 2022, Brunnermeier et al. 2024).
In the 2000s, the limited availability and high price of safe assets were seen as a concern. Caballero et al. (2017) discuss this ‘safe assets shortage’ and its adverse macroeconomic implications. Hence, additional debt issuance by countries such as the US or Germany was seen to have global benefits. More recently, public debt issuance by major safe asset providers, including Germany and the US, has increased substantially and is projected to grow further (International Monetary Fund 2025). At the same time, the premium that investors need to pay for safe assets – commonly called the convenience yield – has declined, suggesting that the shortage of safe assets has abated (Jiang et al. 2025, Schnabel 2025).
This raises a natural question: can the supply of safe assets be too high?
In a new paper (Bellon et al. 2026), we argue that the answer is ‘yes’. Countries can have incentives to issue more debt than is socially optimal, even when fiscal sustainability is not in doubt. The problem is that a larger supply of safe assets erodes the convenience yield that governments earn on their bonds. Lower convenience yields imply higher sovereign borrowing costs and, ultimately, higher taxation to service the debt (Angeletos et al. 2023). The price effect of additional debt issuance, in other words, bites even when default risk is absent.
Why, then, would governments issue ‘too much’ safe debt? The key problem is international spillovers combined with a lack of fiscal policy coordination. Safe sovereign bonds are substitutable from the perspective of investors, especially in tightly financially integrated regions such as the euro area (Bellon and Gnewuch 2024). As a result, debt issuance in one country reduces convenience yields not only at home, but also abroad. While governments internalise the domestic fiscal consequences of lower convenience yields, they might not account for the fiscal costs imposed on other countries. This fiscal externality incentivises excessive issuance and can lead to ‘too much’ safe debt.
The announcement of Germany’s large fiscal expansion in March 2025 provides a salient illustration of these fiscal spillovers (Figure 1). Within two days of the announcement, Germany’s convenience yield declined by 8.7 basis points, implying higher sovereign borrowing costs.1 The effect was not confined to Germany: convenience yields also declined for other euro area countries by an average of 7.6 basis points (left panel). Such spillovers can translate into meaningful fiscal costs. As a back-of-the-envelope estimate, we compute how much the annual interest burden would rise if the yield increase were permanent and applied to all outstanding debt — noting that, since sovereign debt has long maturities, these costs would materialise gradually rather than immediately. For Germany, this cost amounts to 0.055% of GDP (€2.46 billion), while for the rest of the euro area combined, the fiscal cost would be even larger – around 0.074% of GDP (€8.45 billion) – because of higher aggregate debt levels.
Figure 1 Spillover effect and fiscal cost of German fiscal expansion announcement, 4-6 March 2025
These fiscal spillovers have adverse effects, which could, however, be internalised by greater international fiscal policy coordination. Nationally focused governments ignore the costs from additional issuance incurred by foreign governments and thus have an incentive to issue more than is collectively desirable. On the flip side, reducing debt issuance is unattractive because the benefits are diminished by continued issuance elsewhere. But when countries coordinate and jointly restrict debt supply, they can raise convenience yields and lower financing costs for all. We formalise this mechanism in the framework below.
In Bellon et al. (2026), we study a framework in which two governments strategically decide how much debt to issue. In both countries, sovereign bonds are valued not only because they provide a financial return, but also because they are useful as collateral in financial transactions. Investors are therefore willing to pay a convenience yield premium for holding these safe assets. Because the collateral value of bonds is uncertain and can differ across issuers, investors optimally diversify and hold a mix of both countries’ debt.
We compare two cases throughout the analysis. In the first, governments act non-cooperatively and maximise national welfare, taking the issuance of the other country as given. In the second, governments coordinate their debt issuance decisions to maximise joint welfare. Comparing these two cases reveals two distortions that shape equilibrium debt levels.
The first distortion is a fiscal externality. As illustrated in Figure 1, additional debt issuance in one country lowers convenience yields not only domestically, but also abroad. Lower convenience yields imply higher sovereign borrowing costs and therefore higher taxation. Non-cooperative governments internalise the domestic fiscal costs of lower convenience yields, but ignore the fiscal costs imposed on foreign governments. This creates an incentive to issue excessively large amounts of debt relative to the cooperative benchmark.
The second distortion works in the opposite direction. Governments that issue highly valued safe assets possess market power and can benefit from restricting debt supply. By issuing less debt, governments raise convenience yields and extract more rents from foreign bondholders. This mechanism features prominently in the literature on the strategic behaviour of safe asset issuers (Choi et al. 2026, Jiang and Richmond 2024) and implies that non-cooperative governments issue too little debt relative to the cooperative benchmark.
These two forces pull in opposite directions, and their relative strength determines whether non-cooperative governments ultimately issue too much or too little debt.
Our main theoretical result is that the balance of these two distortions depends crucially on public spending needs and bond price spillovers (Figure 2). Higher spending needs strengthen the fiscal externality because they require governments to rely more heavily on taxation, which becomes increasingly distortionary. At the same time, stronger spillovers across bond markets weaken governments’ market power, because they limit their ability to raise their own convenience yield relative to other countries.
Figure 2 High spending needs and large bond market spillovers foster the over-issuance of safe assets
The euro area is particularly exposed to the issue of safe-asset spillovers. Over the past decade, several member states – most notably Germany, France, and the Netherlands – have been perceived by investors as issuers of safe sovereign debt. At the same time, euro area sovereign bond markets are highly integrated, implying strong spillovers from debt issuance across countries (Arcidiacono et al. 2024). Therefore, we apply our framework to study the quantitative implications of safe-asset spillovers and fiscal policy coordination in the euro area.
Our analysis of the calibrated model delivers two main findings. First, over the past decade, the fiscal externality has been the dominant distortion, fostering excessive debt issuance. That is, cooperation prescribes debt levels roughly five percentage points of GDP below those chosen by non-cooperative governments. Second, rising public spending needs meaningfully exacerbate the fiscal externality (Figure 3). A permanent increase in government expenditure of five percentage points of GDP raises non-cooperative over-issuance to 6.4% of GDP. Intuitively, higher spending needs increase the importance of issuing at low cost and therefore strengthen the case for lowering debt to preserve the convenience yield. Without coordination, each government continues to ignore its impact on the – now even tighter – foreign budget (Figure 3).
Figure 3 The prevailing conditions in the euro area incentivise too much safe debt and the excess increases when government expenditure rises
Our results highlight the importance of fiscal policy coordination, especially in tightly financially integrated regions such as the euro area. When governments coordinate and internalise cross-border spillovers, they can achieve better outcomes for all. For the euro area, our calibration exercise indicates that coordinating safe asset issuers choose moderately lower debt levels.
Moreover, the costs of non-coordination increase with public spending pressures. At a time when governments face mounting pressures from the green transition (Wolff and Darvas 2022), ageing populations, higher defence spending, and broader geopolitical risks (Beetsma et al. 2024), the fiscal consequences of debt spillovers grow – strengthening the case for fiscal policy coordination, especially in the euro area. Importantly, this rests not only on ensuring debt sustainability, but also on taking advantage of the convenience yield.
Source : VOXeu
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