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Dealing with Systemic Sovereign Debt Crises: Fiscal Consolidation, Bail-Ins, or Bail-Outs?

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  • Damiano Sandri

    (International Monetary Fund)

Abstract

The paper presents a tractable model to understand how international financial institutions (IFIs) should deal with the sovereign debt crisis of a systemic country, in which case private creditors’ bail-ins entail international spillovers. We use the model to solve for the optimal combination between fiscal consolidation, bail-ins, and bail-outs to restore debt sustainability. For non-systemic countries, only fiscal consolidation and bail-ins should be used, based on an ex-post assessment of their relative costs. Systemic crises raise significant new challenges. First, to reduce the spillovers associated with bail-ins, IFIs should be able to provide bail-outs. Second, to contain the moral hazard effects of bail-outs, IFIs should operate under a binding crisis-resolution framework that limits the provision of bail-outs to highly systemic countries, coupled with more stringent fiscal consolidation requirements.

Suggested Citation

  • Damiano Sandri, 2018. "Dealing with Systemic Sovereign Debt Crises: Fiscal Consolidation, Bail-Ins, or Bail-Outs?," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 66(4), pages 665-693, December.
    • Handle: RePEc:pal:imfecr:v:66:y:2018:i:4:d:10.1057_s41308-018-0067-3
    DOI: 10.1057/s41308-018-0067-3
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    JEL classification:

    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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