Discussion Paper Details

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Title: Deadly Embrace: Sovereign and Financial Balance Sheets Doom Loops

Author(s): Emmanuel Farhi and Jean Tirole

Publication Date: December 2015

Keyword(s): bailouts, feedback loop, shared supervision, sovereign and corporate spreads and sovereign default

Programme Area(s): Financial Economics, International Macroeconomics and Finance and Monetary Economics and Fluctuations

Abstract: The recent unravelling of the Eurozone?s financial integration raised concerns about feedback loops between sovereign and banking insolvency, and provided an impetus for the European banking union. This paper provides a ?double-decker bailout? theory of the feedback loop that allows for both domestic bailouts of the banking system by the domestic government and sovereign debt forgiveness by international creditors or solidarity by other countries. Our theory has important implications for the re-nationalization of sovereign debt, macroprudential regulation, and the rationale for banking unions.

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Bibliographic Reference

Farhi, E and Tirole, J. 2015. 'Deadly Embrace: Sovereign and Financial Balance Sheets Doom Loops'. London, Centre for Economic Policy Research.