DP14891 The Economics of Sovereign Debt, Bailouts and the Eurozone Crisis

Author(s): Pierre-Olivier Gourinchas, Philippe Martin, Todd Messer
Publication Date: June 2020
Keyword(s):
JEL(s): F34, F45
Programme Areas: International Macroeconomics and Finance
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14891

Despite a formal 'no-bailout clause', we estimate significant net present value transfers from the European Union to Cyprus, Greece, Ireland, Portugal and Spain, ranging from roughly 0.5% (Ireland) to 43% (Greece) of 2011 output during the recent Eurozone crisis. We propose a model to analyze and understand bailouts in a monetary union, and the large observed differences across countries. We characterize bailout size and likelihood as a function of the economic fundamentals (economic activity, debt-to-gdp ratio, default costs). Our model embeds a 'Southern view' of the crisis (transfers did not help) and a 'Northern view' (transfers weaken fiscal discipline). While a stronger no-bailout commitment reduces risk-shifting, it may not be optimal from the perspective of the creditor country, even ex-ante, if it increases the risk of immediate insolvency for high debt countries. Hence, the model provides a potential justification for the often decried policy of 'kicking the can down the road'.