Exits and bailouts in a monetary union

This paper analyzes country bailouts in a monetary union within a framework where sovereign default and exit from the union are two separate decisions. The lack of exit precedent creates uncertainty about the exit cost, which might prevent countries from exiting. The first exit can resolve the uncertainty, which is why the union might bail out a troubled country. As the bailout is meant to prevent an exit from the union, it does not exclude subsequent defaults. The model motivates the occurrence of large fiscal transfers within the Eurozone, and explains why they were insufficient to resolve the debt crisis.