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Title: Exit expectations and debt crises in currency unions

Author(s): Alexander Kriwoluzky, Gernot Müller and Martin Wolf

Publication Date: September 2015

Keyword(s): currency union, euro crisis, exit, fiscal policy, redenomination premium, regime-switching model and sovereign debt crisis

Programme Area(s): International Macroeconomics and Finance

Abstract: Membership in a currency union is not irreversible. Expectations of exit may emerge during a sovereign debt crisis, because by exiting countries can redenominate and reduce their liabilities. This possibility alters the dynamics of sovereign debt crises. We establish this formally within a small open economy model of changing policy regimes. The model permits explosive dynamics of debt and sovereign yields inside the currency union and allows us to distinguish between exit expectations and those of an outright default. By estimating the model on Greek data, we quantify the contribution of exit expectations to the crisis dynamics during 2009-2012.

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Bibliographic Reference

Kriwoluzky, A, Müller, G and Wolf, M. 2015. 'Exit expectations and debt crises in currency unions'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=10817