The Economics of Sovereign Debt, Bailouts, and the Eurozone Crisis

By Pierre-Olivier Gourinchas, Philippe Martin, Todd Messer

August 25, 2023

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Pierre-Olivier Gourinchas, Philippe Martin, and Todd Messer. The Economics of Sovereign Debt, Bailouts, and the Eurozone Crisis, (USA: International Monetary Fund, 2023) accessed November 8, 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

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) of 2010 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.

Subject: Collateral, Debt default, Economic integration, External debt, Financial institutions, Loans, Monetary unions, Public debt

Keywords: Bailout size, Bailouts, Collateral, Debt country, Debt default, Debtor country, Euro area, Eurozone crisis, Global, Loans, Monetary Union, Monetary unions, No-bailout clause, Sovereign debt

Publication Details

Pages:

78
Volume:

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DOI:

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Issue:

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Series:

Working Paper No. 2023/177
Stock No:

WPIEA2023177
ISBN:

9798400245503
ISSN:

1018-5941

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