An Imperfect Financial Union With Heterogeneous Regions
IMF Working Papers, September 11, 2018
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- An Imperfect Financial Union With Heterogeneous Regions
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Bibliographic details
- Authors: Filippo Balestrieri, Suman S Basu
- Published: September 11, 2018
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781484375631.001
Summary and main findings
- The paper analyzes 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.
- The borrowing constraint:
- generates sudden stops throughout the South,
- depresses the intra-union interest rate,
- reduces Northern welfare below its unconstrained level,
- has 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.
Mechanisms and concepts emphasized
- Unified debt market with a borrowing constraint
- Sudden stops in the South driven by the borrowing constraint
- Intra-union interest rate depression (shadow interest rate effects implied)
- Welfare impacts:
- Northern welfare reduced below its unconstrained level
- Southern welfare effects ambiguous
- Policy instruments considered:
- North-to-South governmental loans (conditional on Southern government commitment capacity)
- Southern debt relief combined with budget-neutral taxes and subsidies (when commitment capacity absent)
- Laissez-faire equilibrium and the potential for Pareto-improving interventions during crises
Policy recommendations and scenarios
- Permit negotiated loans and debt relief in later sudden-stop periods from the pre-crisis perspective, conditional on sufficient heterogeneity across regions in the union.
- Use governmental loans from North to South when Southern governments can commit to repay to achieve Pareto improvements during sudden stops.
- Use combinations of Southern debt relief and budget-neutral tax-subsidy policies when Southern governments cannot commit to repay.
Robustness and extensions
- Results are robust to:
- production,
- limited financial openness of the union.
Content in this bundle
- An Imperfect Financial Union with Heterogeneous Regions, WP/18/205, September 2018