Resolving sovereign debt crises: Opening or closing the tap?
AbstractThis paper first describes the ingredients the present crisis in the euro zone and then evaluates the key options that policy makers face in resolving the crisis and avoiding similar crises in the future. I argue that the crisis should not be seen as caused by government profligacy alone. In many troubled countries, an unsustainable build-up of private sector debt was involved as well. I argue that a more fundamental problem is that the euro zone lacks an adjustment mechanism for balance of payments crises that may arise in its member countries, with or without excessive government deficits. The metaphor of taps to be opened or closed by policy is used to discuss the core trade offs that policy makers face. I discuss monetary taps, bailout taps, austerity taps and devaluation taps. I propose a simple model of government bond markets with sovereign insolvency to be used in order to evaluate EU-type bailouts. I discuss the pros and cons of austerity as a precondition for such bailouts, and I criticize the use of Target2 as a mechanism to absorb balance of national payments crises. --
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Bibliographic InfoPaper provided by University of Tuebingen, Faculty of Economics and Social Sciences in its series University of Tuebingen Working Papers in Economics and Finance with number 39.
Date of creation: 2012
Date of revision:
Euro; Sovereign risk; Sovereign default; Government solvency; Lender of last resort; External balance; Balance of payments;
Find related papers by JEL classification:
- F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
- F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-07-08 (All new papers)
- NEP-EEC-2012-07-08 (European Economics)
- NEP-MON-2012-07-08 (Monetary Economics)
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