DP12921 The Dynamics of Sovereign Debt Crises and Bailouts
|Author(s):||Francisco Roch, Harald Uhlig|
|Publication Date:||May 2018|
|Keyword(s):||Bailouts, default, Endogenous Borrowing Constraints, Eurozone Debt Crisis, long-term debt, OMT, Self-fulfilling Crises|
|Programme Areas:||International Macroeconomics and Finance|
|Link to this Page:||www.cepr.org/active/publications/discussion_papers/dp.php?dpno=12921|
Motivated by the recent European debt crisis, this paper investigates the scope for a bailout guarantee in a sovereign debt crisis. Defaults may arise from negative income shocks, government impatience or a "sunspot"-coordinated buyers strike. We introduce a bailout agency, and characterize the strategy with the minimal actuarially fair intervention which guarantees the no-buyers-strike fundamental equilibrium, relying on the market for residual financing. The intervention makes it cheaper for governments to borrow, inducing them borrow more, leaving default probabilities possibly rather unchanged. The maximal backstop will be pulled precisely when fundamentals worsen.