The Dynamics of Sovereign Debt Crises and Bailouts
IMF Working Papers, July 11, 2016
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- The Dynamics of Sovereign Debt Crises and Bailouts
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Bibliographic details
- Authors: Francisco Roch, Harald Uhlig
- Published: July 11, 2016
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781475581027.001
Summary and research question
- Motivated by the recent European debt crisis, the paper investigates the scope for a bailout guarantee in a sovereign debt crisis.
- Defaults may arise from:
- negative income shocks;
- government impatience;
- a "sunspot"-coordinated buyers strike.
- The paper introduces a bailout agency and characterizes the minimal actuarially fair intervention that guarantees the no-buyers-strike fundamental equilibrium, relying on the market for residual financing.
Model features and mechanism
- Introduction of a bailout agency that provides a backstop guarantee.
- Characterization of the minimal actuarially fair intervention required to sustain the fundamental (no-buyers-strike) equilibrium.
- Interaction with the market for residual financing: the backstop reduces borrowing costs but does not eliminate private market participation.
Key findings
- The intervention makes it cheaper for governments to borrow, inducing them to borrow more.
- Increased borrowing can leave default probabilities possibly rather unchanged.
- The maximal backstop will be pulled precisely when fundamentals worsen.
- Defaults in the model can be driven by multiple channels: income shocks, policy impatience, or coordination failures ("sunspot" buyers strike).
Policy implications and considerations
- A targeted, actuarially fair bailout guarantee can stabilize creditor coordination and prevent buyer strikes without fully replacing private financing.
- Lower borrowing costs from guarantees may create moral hazard by inducing greater debt accumulation—monitoring of borrowing incentives is essential.
- Design of backstops should account for the timing: maximal support is used when fundamentals deteriorate, implying contingent and state-dependent intervention rules.
Content in this bundle
- _wp16136 - References