The Eurozone Needs Exit Rules
This paper argues that the key issue for defining and solving the Eurozoneâ€™s (EZ) difficulties lies in readjusting the relationship between the centre and the periphery of the EZ. Our argument proceeds in two steps. Firstly, the basic finance problem of a centre-periphery system is captured by a threat game with perfect but incomplete information. To get close to the essence of todayâ€™s crisis we analyze to what extent a â€˜troubledâ€™ periphery EZ member can negotiate a bailout from the center due to the existence of a negative externality arising from its potential default. Secondly, we analyze how establishing â€˜exit rulesâ€™, which have recently also been advocated by Jacques Delors, would shift the centre-periphery relationship in a way that safeguard the stability of the EZ. We demonstrate that such rules may help limiting the scope for brinkmanship whereby fiscal problems in one member create a negative externality for the rest of the EZ. We show that such rules will strengthen the EZ through at least four channels.
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