Fiscal Policy, Eurobonds and Economic Recovery: Some Heterodox Policy Recipes against Financial Instability and Sovereign Debt Crisis

In this paper, we propose a simple post-Keynesian model on the linkages between the financial and real side of an economy. We show how financial variables may feedback each other and affect economic activity, possibly giving rise to intrinsically unstable economic processes. Through these destabilizing mechanisms, we explain why governments’ intervention in the aftermath of the 2007 financial meltdown has been largely useless to restore financial tranquility, and transformed a private debt crisis into a sovereign debt one. The paper ends up by looking at the long run and to the interaction between long-term growth potential and public debt sustainability. We consider the European economic context and the macroeconomic difficulties several EU members currently face. We stress that: (i) financial turbulences may trigger permanent reductions in long-term growth potential and unsustainable public debt dynamics; (ii) strong institutional discontinuity such as EU financial assistance to member countries is probably the only way to restore growth and ensure long-run public debt sustainability.