An Imperfect Financial Union With Heterogeneous Regions

September 11, 2018

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Filippo Balestrieri, and Suman S Basu. An Imperfect Financial Union With Heterogeneous Regions, (USA: International Monetary Fund, 2018) accessed September 19, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Summary

We analyze a union of financially-integrated yet politically-sovereign countries, where households in the Northern core of the union lend to those in the Southern periphery in a unified debt market subject to a borrowing constraint. This constraint generates sudden stops throughout the South, depresses the intra-union interest rate, and reduces Northern welfare below its unconstrained level, while having ambiguous effects on Southern welfare. During sudden stops, Pareto improvements can be achieved using North-to-South governmental loans if Southern governments have the capacity to commit to repay, or using a combination of Southern debt relief and budget-neutral taxes and subsidies if they do not. From the pre-crisis perspective, it is Pareto-improving to allow loans and debt relief to be negotiated in later sudden-stop periods as long as the regions in the union are sufficiently heterogeneous to begin with. We show that our results are robust to production and to limited financial openness of the union.

Subject: Asset and liability management, Balance of payments, Consumption, Debt relief, Financial crises, Financial institutions, Loans, National accounts, Sudden stops

Keywords: Borrowing constraint, Capital flows, Consumption, Debt relief, Europe, Financial union, Governmental loan, Heterogeneous regions, Interest rate effect, Laissez-faire equilibrium, Loans, Lower bound, Math display, Nontradable goods, Pareto efficiency, Pareto gain, Pareto improvement, Pareto-improving intervention, Shadow interest rate, Sudden stop, Sudden stops, Tax-subsidy policy, WP

Publication Details

Pages:

66
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2018/205
Stock No:

WPIEA2018205
ISBN:

9781484375631
ISSN:

1018-5941

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