Reviving PADRE: A Balance Sheet Approach to Euro Area Debt in an Age of Geopolitical Risk –

Euro area governments face mounting geopolitical demands on their budgets while carrying legacy debt that European Central Bank instruments can stabilise but not reduce. This article revisits the politically acceptable debt restructuring in the eurozone (PADRE) proposal of Pierre Pâris and Charles Wyplosz from 2014, which converts excess sovereign debt into zero-coupon perpetuities held by the Eurosystem, at no cost to creditors or other member states, and argues that its revival is now warranted.

The euro area is entering a new phase of macroeconomic vulnerability. An energy shock linked to the conflict in the Middle East has revived inflation and led the European Central Bank (ECB) to resume raising rates, while growth prospects weaken. Heightened geopolitical tensions – persistent conflicts at Europe’s borders, global trade fragmentation, an increasingly volatile tariff environment and energy insecurity – are tilting the outlook towards stagnation. These pressures are also compressing public revenues and raising contingent fiscal demands, at a moment when governments are least well placed to absorb them.

These shocks operate through several reinforcing channels: disrupted supply chains, weaker investment, higher precautionary savings and tighter credit conditions following past interest rate increases. The result is a fragile macroeconomic configuration, characterised by weakening demand, subdued growth prospects and elevated uncertainty, precisely when fiscal policy would typically be expected to provide counter-cyclical support. Yet several euro area governments enter this phase carrying a structural handicap: high and uneven public debt ratios that severely constrain their room for manoeuvre.

It is precisely this combination – geopolitical pressure raising the need for fiscal action while legacy debt stocks foreclose it – that gives the case for a structural balance sheet solution its renewed urgency.

Debt overhang as a binding constraint

Public debt-to-GDP ratios in several member states remain significantly above pre-pandemic levels. While the prolonged era of negative or near-zero real interest rates had previously contained the burden of debt service, this condition no longer holds. Even a moderate stabilisation of nominal rates leaves governments carrying heavy legacy debt stocks whose servicing claims crowd out productive expenditure. The empirical literature documents a persistent negative association between elevated public debt ratios and long-run growth, operating through channels including higher risk premia, lower public investment and heightened fiscal uncertainty (Reinhart & Rogoff, 2010; Pescatori et al., 2014; Eberhardt & Presbitero, 2015).

The reactivation of EU fiscal rules, however reformed, reintroduces binding consolidation requirements, frequently in a pro-cyclical direction: member states are pressured to tighten budgets precisely when macroeconomic conditions would call for fiscal support.

This combination produces a textbook debt overhang problem (Myers, 1977; Krugman, 1988): governments rationally restrict productive spending, private investment is depressed by expectations of higher future taxation or fiscal instability, and recovery remains precarious and incomplete. The political economy consequences compound the problem. Prolonged austerity, weak growth and social discontent fuel polarisation and extremism, while financial markets internalise political uncertainty, amplify sovereign spreads and close the adverse feedback loop.

The limits of current policy instruments

Over the past decade, the euro area has relied heavily on the ECB to stabilise sovereign debt markets. Large-scale asset purchase programmes, targeted long-term refinancing operations, and contingent instruments have compressed spreads and preserved orderly market functioning. Their effectiveness in addressing liquidity stress and market dysfunction is not in question.

What is in question is their structural adequacy. These tools share a fundamental limitation: they operate on flows, not on stocks. Quantitative easing absorbs sovereign bonds into the Eurosystem’s balance sheet but does not extinguish the underlying liabilities. Governments continue to service the full stock of debt, whether held by the private sector or by the central bank. Spread-compression instruments are conditional and contingent: useful for managing market expectations but incapable of reducing debt burdens in any durable sense.

As a result, the euro area finds itself in an unsustainable configuration: debt stocks are persistently high, fiscal space is structurally constrained, and monetary policy is bearing a disproportionate share of the macroeconomic stabilisation burden. Managing this configuration becomes progressively more difficult as geopolitical and recessionary risks intensify. In effect, the euro area has developed a sophisticated set of instruments to manage liquidity and market functioning but lacks a mechanism to address the legacy stock of public debt directly.

The PADRE mechanism

Addressing the debt overhang calls for a conceptual shift: from flow adjustments – fiscal consolidation, market interventions – to a direct operation on the stock dimension of public sector balance sheets.

The politically acceptable debt restructuring in the eurozone (PADRE) proposal, advanced by Pâris and Wyplosz (2014), provides a coherent framework for exactly this purpose.¹ It was formulated within an orthodox macroeconomic framework and explicitly designed to remain within the institutional and legal architecture of the euro area.

The mechanism involves three core steps.

Step 1: Secondary market acquisition. An agreement is struck between the highly indebted eurozone governments and the European System of Central Banks, under the formal aegis of EU institutions. The ECB and the relevant national central banks (NCBs) purchase a defined share of each country’s sovereign debt on the secondary market. The share is calibrated to reduce each country’s outstanding public debt to a pre-agreed sustainable threshold, for example, 80% of GDP. Purchases take place over a defined time window, using established secondary market procedures.

Step 2: Conversion into perpetual, zero-coupon instruments. The acquired debt is converted into perpetuities bearing zero interest. These instruments carry no coupon and no redemption date, making them economically close, from the issuer’s perspective, to a permanent maturity transformation: interest payments cease entirely, and the principal never falls due. Existing private bondholders are fully protected – bonds are purchased at market prices, no haircuts are imposed, and no bank balance sheet losses arise. The operation therefore avoids the bank losses and contagion that conventional restructurings trigger.

Step 3: Monetary neutralisation through note issuance. To prevent the debt purchases from generating an inflationary monetary expansion, the NCBs simultaneously issue interest-bearing notes in the market in amounts equivalent to the bonds acquired. The increase in the monetary base is thus fully offset by new NCB liabilities. There is no debt monetisation: new money creation is matched by new central bank obligations. The operation extends, rather than breaks with, the logic of existing secondary market programmes. It is designed to be compatible with the prohibition on monetary financing under Article 123 of the Treaty on the Functioning of the European Union (TFEU), though its precise legal admissibility would depend on institutional design details and, ultimately, on the interpretation by the European Court of Justice (ECJ). In this sense, PADRE can be understood as a restructuring of the public sector’s consolidated balance sheet, rather than a transfer across sectors.

Box 1 is a simple illustrative calibration that helps clarify the scale and intertemporal logic of the mechanism.

Box 1
Illustrative calibration: Italy

Source: Author’s calculations based on Istat and Eurostat data.

The economics of cost absorption: Who pays and when

The critical economic question is not whether the PADRE operation involves a cost – it does – but who bears it and how it is distributed over time. The answer has two layers that must be carefully distinguished.

The NCBs as intermediary vehicle

The immediate accounting cost falls on the NCBs. Since they pay market interest on the notes issued but receive no interest on the zero-coupon perpetuities they hold, they incur a structural income shortfall – an ongoing loss that will persist until their future earnings exceed it. It is the NCBs’ unique institutional nature as sovereign money issuers, unconstrained by the capitalisation requirements that govern private financial institutions, which makes them the only plausible vehicles for an operation of this kind. There is no private agent nor government that possesses the financial resilience and institutional longevity needed to absorb losses over the decades-long time horizon that PADRE requires.

It bears noting, moreover, that NCBs would likely fund their notes at a lower rate than the governments whose bonds they absorb, since, as money-issuing institutions, they face none of the rollover risk that sovereigns face: the effective interest differential – and thus the income shortfall – is therefore smaller than a naive comparison of sovereign borrowing costs would suggest, making the intertemporal recovery path more favourable than the baseline calibration in Box 1 implies.

Future national taxpayers as ultimate bearers

The NCBs, however, are not the ultimate bearers of the cost. They are the conduit through which the restructuring cost is distributed to the future taxpayers of the participating countries. Recovery proceeds through three channels, each of which reduces future public revenues: first, the NCBs retain seigniorage transfers that would otherwise flow to national treasuries; second, they withhold annual tax payments owed to governments; and third, they receive shares of any extraordinary fiscal revenues that governments elect to allocate to accelerate the process. In each case, it is the national fiscal base – and thus succeeding generations – that ultimately absorbs the restructuring cost.

This is, in essence, a form of debt restructuring whose burden falls on national taxpayers, through the fiscal channel, rather than on private creditors or foreign partners. PADRE does not make debt disappear; it converts a present sovereign liability into a deferred fiscal cost, spread across time through the intermediation of the central bank. As Pâris and Wyplosz (2014) demonstrate, under plausible GDP and interest-rate dynamics, several decades would be required before cumulative NCB earnings begin to exceed the cumulative interest burden on outstanding notes.

The intergenerational allocation of costs is both economically efficient and ethically defensible. The debts being restructured are themselves a legacy of past policy choices, accumulated over decades; distributing the adjustment burden across future generations reflects sound principle. From a consolidated public-sector perspective, the operation does not eliminate the resource cost of past borrowing; it reallocates its timing and distribution across agents and time.

Central bank losses and intertemporal solvency

Central bank capital matters, and the concern about NCB losses under PADRE deserves a direct answer rather than dismissal. A central bank that operates with severely impaired equity over a prolonged period faces genuine risks to its credibility and, ultimately, to its operational independence. These concerns are legitimate. The correct response, however, is not to reject the PADRE mechanism on these grounds, but to assess it on its own intertemporal terms.

The NCBs’ losses under PADRE are real but not permanent. Evaluated in present-value terms, the cumulative cost of the operation – the net present value of the interest differential between notes liabilities and zero-coupon assets – is covered by the present value of future earnings through the three recovery channels described above. The NCBs are, in this precise sense, intertemporally solvent with respect to the operation: losses are front-loaded; recovery is back-loaded. The present-value arithmetic closes (Del Negro & Sims, 2015).

Central banks, as sovereign money issuers, can sustain this temporal mismatch between near-term losses and long-term recovery – without impairing their monetary policy functions. For precisely this reason, they are the only institutional agents capable of bridging this gap (Buiter, 2008). History confirms this: several central banks have operated through extended periods of negative or near-zero equity without any impairment of their monetary policy effectiveness. Episodes in Chile, Israel and the Czech Republic illustrate that central banks can operate with impaired equity for extended periods, provided their institutional credibility and policy mandates remain intact (Stella, 1997, 2005).

The key conclusion is that PADRE does not entail a subsidy to indebted governments at the expense of the Eurosystem. It entails a deferred fiscal burden borne by national taxpayers, intermediated through institutions that uniquely possess the balance sheet resilience and longevity to make such deferral credible and operationally viable.

Legal framework and moral hazard

On legal compatibility, PADRE is designed to operate within existing Treaty constraints. Purchases occur exclusively on secondary markets – as under current programmes – and the concurrent issuance of notes neutralises any inflationary monetary expansion. The structure is therefore analogous in key respects to arrangements the ECJ has assessed in connection with the ECB’s asset purchase programmes (ECJ, 2015, 2018). That said, the conversion of acquired bonds into zero-coupon perpetuities is a novel feature for which no direct ECJ precedent exists. Its compatibility with Article 123 TFEU cannot be assumed; it would require careful institutional design and, ultimately, judicial clarification. This legal uncertainty is a genuine challenge that any revival of PADRE would need to address frontally, not finesse.

A related issue is statistical: under current rules, government bonds held by NCBs remain in Maastricht debt at nominal value, so the reduction in reported debt ratios would require a specific classification decision by Eurostat.

On moral hazard, the risk is real and must be taken seriously. Governments that regain fiscal space through PADRE might be tempted towards renewed fiscal imprudence. The proposal addresses this through a self-enforcing mechanism: participating governments would be required to enact a formally binding commitment through national parliaments – thereby binding present and future governments alike – not to exceed the agreed sustainable debt threshold. Enforcement is automatic: in the event of a breach, a commensurate share of the zero-coupon perpetuities held by the NCB is reconverted into ordinary market-rate bonds at short maturity, instantly reinflating the debt burden and triggering an immediate deterioration in sovereign creditworthiness.

This design merits scrutiny. The self-enforcing character of the reconversion mechanism depends on the institutional capacity and political will to monitor compliance and activate the trigger without discretionary delay. Strengthening this dimension – for example, by embedding independent surveillance in EU fiscal frameworks and making the threshold subject to qualified majority confirmation before any modification – would make the deterrent more credible and the commitment more durable.

It is also worth noting that the current policy regime already involves substantial implicit support for sovereign debt markets, a consequence of the structural fragility of sovereign borrowing in a monetary union without a fiscal backstop (De Grauwe, 2012). A one-off, rule-based PADRE operation would, in this light, enhance rather than undermine fiscal discipline: by resetting debt ratios to sustainable levels, it would allow EU fiscal rules to function with genuine effectiveness, rather than as paper constraints on economies that remain structurally over-indebted.

Policy implications for the current conjuncture

A common instinct is to treat any sovereign debt restructuring as inherently destabilising – a signal of distress that triggers contagion, penalises creditors and unsettles markets. PADRE inverts this logic entirely. Bonds are purchased at market prices, no haircuts are imposed, no credit event is triggered, existing holders are made whole. But the market implications go beyond mere neutrality. By reducing sovereign debt ratios to sustainable levels, PADRE structurally improves the repayment capacity of participating governments on the residual debt that remains in private hands. Creditors of that residual stock find themselves in a materially stronger position than before: rollover risk is lower, the probability of future fiscal distress is reduced, and sovereign spreads can be expected to compress accordingly. The operation does not redistribute risk from debtors to creditors; it reduces aggregate sovereign risk, to the benefit of both. Markets would not be disrupted by a well-designed PADRE operation – they would price it as the durable stabilisation that decades of temporary interventions have failed to deliver.

The broader policy case follows directly. PADRE would restructure sovereign debt in a transparent, rule-based and institutionally accountable manner. It would restore fiscal space for counter-cyclical policy, reduce the excessive stabilisation burden currently borne by monetary policy and mitigate the political economy risks – extremism, polarisation, erosion of democratic trust – that protracted austerity and weak growth typically generate.

Whether the ECB and the NCBs would welcome such an operation is a separate question. It is one on which this article takes no position: the case for PADRE rests on its own analytical merits and on the structural gap it addresses in the policy architecture of the euro area. The relevant question for policymakers is not whether PADRE is administratively convenient, but whether the euro area can durably manage a combination of persistently high debt stocks, constrained fiscal space and mounting geopolitical pressure without a mechanism of this kind.

Conclusion

The euro area has demonstrated considerable institutional adaptability through successive crises. But its approach to the stock dimension of public debt has remained resolutely incremental, relying on temporary instruments that address symptoms without correcting the underlying balance sheet imbalances.

The current conjuncture calls for a more fundamental response. PADRE offers a coherent, operationally feasible, and – subject to careful institutional design – legally defensible mechanism. Reviving this proposal is not an exercise in nostalgia for past debates; it is a response to a type of imbalance that current policy instruments are not designed to address, and whose political and economic costs are becoming harder to defer.

• 1 The author has previously argued for the relevance of the PADRE proposal in the context of democratic resilience and advanced economy debt sustainability (Bossone, 2024, 2026). The present article offers a more systematic treatment of the mechanism’s economic and institutional logic, with particular attention to legal uncertainty, enforcement design and the conjunctural case for revival.

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