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Welfare gains of bailouts in a sovereign default model

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  • Pancrazi, Roberto
  • Seoane, Hernán D.
  • Vukotić, Marija

Abstract

We examine the welfare effects of bailouts in economies exposed to sovereign default risk. When a government of a small open economy requests a bailout from an international financial institution, it receives a non-defaultable loan of size G that comes with imposed debt limits. The government endogenously asks for the bailout during recessions and repays it when the economy recovers. Hence, the bailout acts as an imperfect state contingent asset that makes the economy better off. The bailout duration is endogenous and increases with its size. The bailout size creates non-trivial tradeoffs between receiving a larger amount of relatively cheap resources precisely in times of need on the one hand, and facing longer-lasting financial constraints and accumulated interest payments, on the other hand. We characterize and quantify these tradeoffs and document that welfare gains of bailouts are hump-shaped in the size of bailout loans.

Suggested Citation

  • Pancrazi, Roberto & Seoane, Hernán D. & Vukotić, Marija, 2020. "Welfare gains of bailouts in a sovereign default model," Journal of Economic Dynamics and Control, Elsevier, vol. 113(C).
  • Handle: RePEc:eee:dyncon:v:113:y:2020:i:c:s0165188920300361
    DOI: 10.1016/j.jedc.2020.103867
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    3. Perazzi, Elena, 2022. "Sovereign Bailouts: Are Ex-Ante Conditions Useful?," MPRA Paper 113462, University Library of Munich, Germany.

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    More about this item

    Keywords

    Default; Sovereign Risk; Bailouts;
    All these keywords.

    JEL classification:

    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems

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