Working Paper: CEPR ID: DP12921
Authors: Harald Uhlig; Francisco Roch
Abstract: 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.
Keywords: default; bailouts; self-fulfilling crises; endogenous borrowing constraints; long-term debt; OMT; eurozone debt crisis
JEL Codes: F34; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| negative income shocks (F61) | sovereign debt defaults (H63) |
| government impatience (H11) | sovereign debt defaults (H63) |
| sunspot-coordinated buyers strike (D74) | sovereign debt defaults (H63) |
| bailout agency intervention (G28) | borrowing costs for governments (H74) |
| bailout agency intervention (G28) | borrowing levels (H74) |
| bailout agency intervention (G28) | default probabilities (C25) |
| bailout agency's actions (G28) | stability of sovereign debt markets (F34) |