Country Solidarity, Private Sector Involvement and the Contagion of Sovereign Crises
AbstractClassic analyses of sovereign debt make no predictions concerning the allocation of risk between the market and the official sector or among official sector creditors. To open the black box of the composition of a sovereign's foreign liabilities, this paper develops a new framework and distinguishes between ``ex-post solidarity'', aimed at avoiding collateral damages inflicted by a distressed country's default, and ``contractual solidarity'', illustrated by joint-and-several liability or lines of credit, that creates formal modes of insurance. When countries differ substantially in their probability of distress, the optimal mechanism takes the form of a debt brake together with mixed public-private financing for the weaker country; no joint liability emerges. By contrast, in a more symmetrical, mutual-insurance context, contractual solidarity in the form of joint liability is optimal provided that country shocks are sufficiently independent and spillovers costs sufficiently large relative to default costs. Joint liability increases both borrowing capability and the risk of contagion. Spillovers, when endogenized, are larger under mutual insurance than under one-way insurance. Finally, the paper considers the possibility of debt monetization, comparing the outcomes under a currency union and an own currency. It studies whether a currency area is more conducive to bailouts and whether bailouts are optimally denominated in domestic or foreign currency.
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Bibliographic InfoPaper provided by Toulouse School of Economics (TSE) in its series TSE Working Papers with number 12-375.
Date of creation: Jun 2012
Date of revision: Sep 2012
Sovereign debt; joint liability; bailouts; contagion; private sector involvement; debt monetization;
Other versions of this item:
- Tirole, Jean, 2012. "Country Solidarity, Private Sector Involvement and the Contagion of Sovereign Crises," IDEI Working Papers 761, Institut d'Économie Industrielle (IDEI), Toulouse, revised Sep 2012.
- E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
- F34 - International Economics - - International Finance - - - International Lending and Debt Problems
- H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt
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- Tirole, Jean, 2012. "The Euro Crisis: Some Reflexions on Institutional Reform," Open Access publications from University of Toulouse 1 Capitole http://neeo.univ-tlse1.fr, University of Toulouse 1 Capitole.
- Lucas, André & Schwaab, Bernd & Zhang, Xin, 2013. "Conditional euro area sovereign default risk," Working Paper Series 269, Sveriges Riksbank (Central Bank of Sweden).
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