The Economics of Sovereign Debt, Bailouts and the Eurozone Crisis
Abstract
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 a whopping 43% (Greece) of2010 output during the 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.' Mapping the model to the estimated transfers, we find that the main purpose of the outsized Greek bailout was to prevent an exit from the eurozone and possible contagion. Bailouts to avoid sovereign default were comparatively modest. Appendix (PDF)
Board of Governors of the Federal Reserve System International Finance Discussion Papers ISSN 1073-2500 (Print) ISSN 2767-4509 (Online) Number 1351 August 2022 The Economics of Sovereign Debt, Bailouts and the Eurozone Crisis Pierre-Olivier Gourinchas, Philippe Martin, and Todd Messer Please cite this paper as: Gourinchas, Pierre-Olivier, Philippe Martin, and Todd Messer (2022). “The Economics of Sovereign Debt, Bailouts and the Eurozone Crisis,” International Finance Discussion Papers 1351. Washington: Board of Governors of the Federal Reserve System, https://doi.org/10.17016/IFDP.2022.1351. NOTE: International Finance Discussion Papers (IFDPs) are preliminary materials circulated to stimulate discussion and critical comment. The analysis and conclusions set forth are those of the authors and do not indicate concurrence by other members of the research staff or the Board of Governors. References in publications to the International Finance Discussion Papers Series (other than acknowledgement) should be cleared with the author(s) to protect the tentative character of these papers. Recent IFDPs are available on the Web at www.federalreserve.gov/pubs/ifdp/. This paper can be downloaded without charge from the Social Science Research Network electronic library at www.ssrn.com.
Cite this document
Pierre-Olivier Gourinchas, Philippe Martin, & and Todd Messer (2022). The Economics of Sovereign Debt, Bailouts and the Eurozone Crisis (IFDP 2022-1351). Board of Governors of the Federal Reserve System, International Finance Discussion Papers. https://whenthefedspeaks.com/doc/ifdp_2022-1351
@techreport{wtfs_ifdp_2022_1351,
author = {Pierre-Olivier Gourinchas and Philippe Martin and and Todd Messer},
title = {The Economics of Sovereign Debt, Bailouts and the Eurozone Crisis},
type = {International Finance Discussion Papers},
number = {2022-1351},
institution = {Board of Governors of the Federal Reserve System},
year = {2022},
url = {https://whenthefedspeaks.com/doc/ifdp_2022-1351},
abstract = {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 a whopping 43% (Greece) of2010 output during the 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.' Mapping the model to the estimated transfers, we find that the main purpose of the outsized Greek bailout was to prevent an exit from the eurozone and possible contagion. Bailouts to avoid sovereign default were comparatively modest. Appendix (PDF)},
}