Working Paper: CEPR ID: DP14891
Authors: Pierre-Olivier Gourinchas; Philippe Martin; Todd Messer
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 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’.
Keywords: sovereign debt; bailouts; eurozone crisis
JEL Codes: F34; F45
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| significant net present value transfers from the European Union to countries such as Cyprus, Greece, Ireland, Portugal, and Spain (O52) | likelihood of bailouts increases (H81) |
| costs of default for creditor countries exceed resources needed by the debtor country to avoid default (F34) | likelihood of a bailout increases (H81) |
| transfers may not help recipient countries in terms of improving overall fiscal situation (F35) | distort ex ante borrowing incentives (H31) |
| distort ex ante borrowing incentives (H31) | excessive debt issuance (H63) |
| stronger no-bailout commitment (G28) | reduce risk-shifting (G32) |
| stronger no-bailout commitment may not be optimal for creditor countries if it leads to immediate insolvency for high-debt countries (F34) | creditor countries' preferences regarding bailouts (F34) |