## An Imperfect Financial Union With Heterogeneous Regions

_IMF Working Papers, September 11, 2018_

## Source details

**Canonical URL:** [An Imperfect Financial Union With Heterogeneous Regions](https://www.imf.org/en/publications/wp/issues/2018/09/11/an-imperfect-financial-union-with-heterogeneous-regions-46214)

## Other formats

- [Markdown version](/en/publications/wp/issues/2018/09/11/an-imperfect-financial-union-with-heterogeneous-regions-46214/index.md)
- [Structured JSON version](/en/publications/wp/issues/2018/09/11/an-imperfect-financial-union-with-heterogeneous-regions-46214/index.json)
- [Bundle manifest](/en/publications/wp/issues/2018/09/11/an-imperfect-financial-union-with-heterogeneous-regions-46214/bundle-manifest.json)

## 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**
  - [An Imperfect Financial Union with Heterogeneous Regions, WP/18/205, September 2018 (Markdown version)](/-/media/files/publications/wp/2018/wp18205.pdf.md){rel="alternate" type="text/markdown"}
  - [An Imperfect Financial Union with Heterogeneous Regions, WP/18/205, September 2018 (PDF)](/-/media/files/publications/wp/2018/wp18205.pdf){rel="external" type="application/pdf"}

---

_Source: https://www.imf.org/en/publications/wp/issues/2018/09/11/an-imperfect-financial-union-with-heterogeneous-regions-46214_