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Deadly Embrace: Sovereign and Financial Balance Sheets Doom Loops

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  • Emmanuel Farhi
  • Jean Tirole

Abstract

The recent unravelling of the Eurozone’s financial integration raised concerns about feedback loops between sovereign and banking insolvency. This article provides a theory of the feedback loop that allows for both domestic bailouts of the banking system and sovereign debt forgiveness by international creditors or solidarity by other countries. Our theory has important implications for the re-nationalization of sovereign debt, macroprudential regulation, and the rationale for banking unions.

Suggested Citation

  • Emmanuel Farhi & Jean Tirole, 2018. "Deadly Embrace: Sovereign and Financial Balance Sheets Doom Loops," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 85(3), pages 1781-1823.
    • Handle: RePEc:oup:restud:v:85:y:2018:i:3:p:1781-1823.
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    File URL: http://hdl.handle.net/10.1093/restud/rdx059
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    Keywords

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    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • F65 - International Economics - - Economic Impacts of Globalization - - - Finance
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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