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Deadly Embrace: Sovereign and Financial Balance Sheets Doom Loops

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  • Farhi, Emmanuel
  • Tirole, Jean

Abstract

The recent unravelling of the Eurozone’s financial integration raised concerns about feedback loops between sovereign and banking insolvency, and provided an impetus for the European banking union. This paper provides a “double-decker bailout” theory of the feedback loop that allows for both domestic bailouts of the banking system by the domestic government 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

  • Farhi, Emmanuel & Tirole, Jean, 2015. "Deadly Embrace: Sovereign and Financial Balance Sheets Doom Loops," CEPR Discussion Papers 11024, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:11024
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    Cited by:

    1. Neyer, Ulrike & Sterzel, André, 2017. "Capital requirements for government bonds: Implications for bank behaviour and financial stability," DICE Discussion Papers 275, University of Düsseldorf, Düsseldorf Institute for Competition Economics (DICE).
    2. Abbassi, Puriya & Bräuning, Falk & Fecht, Falko & Peydró, José-Luis, 2014. "Cross-border liquidity, relationships and monetary policy: Evidence from the Euro area interbank crisis," Discussion Papers 45/2014, Deutsche Bundesbank.
    3. Yusuf Soner Baskaya & Sebnem Kalemli-Ozcan, 2016. "Sovereign Risk and Bank Lending: Evidence from 1999 Turkish Earthquake," NBER Working Papers 22335, National Bureau of Economic Research, Inc.
    4. Eva m. Berger & Guenther Koenig & Henning Müller & Felix Schmidt & Daniel Schunk, 2017. "Self-Regulation Training and Job Search Effort: A Natural Field Experiment within an Active Labor Market Program," Working Papers 1712, Gutenberg School of Management and Economics, Johannes Gutenberg-Universität Mainz.
    5. Pierre-Olivier Gourinchas & Thomas Philippon & Dimitri Vayanos, 2017. "The Analytics of the Greek Crisis," NBER Macroeconomics Annual, University of Chicago Press, vol. 31(1), pages 1-81.
    6. Acharya, Viral & Pierret, Diane & Steffen, Sascha, 2016. "Lender of last resort versus buyer of last resort: The impact of the European Central Bank actions on the bank-sovereign nexus," ZEW Discussion Papers 16-019, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
    7. Alessandro Beber & Daniela Fabbri & Marco Pagano & Saverio Simonelli, 2015. "Short-Selling Bans and Bank Stability," CSEF Working Papers 423, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy, revised 15 Dec 2017.
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    12. Anil Ari, 2015. "Sovereign Risk and Bank Risk-Taking," Working Papers 202, Oesterreichische Nationalbank (Austrian Central Bank).
    13. Markus K. Brunnermeier & Sam Langfield & Marco Pagano & Ricardo Reis & Stijn Van Nieuwerburgh & Dimitri Vayanos, 2017. "ESBies: safety in the tranches," Economic Policy, CEPR;CES;MSH, vol. 32(90), pages 175-219.
    14. Stefan Avdjiev & Leonardo Gambacorta & Linda S. Goldberg & Stefano Schiaffi, 2017. "The Shifting Drivers of Global Liquidity," NBER Working Papers 23565, National Bureau of Economic Research, Inc.
    15. Jakob de Haan & Jeroen Hessel & Niels Gilbert, 2014. "Reforming the architecture of EMU: Ensuring stability in Europe," DNB Working Papers 446, Netherlands Central Bank, Research Department.
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    17. Markus K. Brunnermeier & Luis Garicano & Philip R. Lane & Marco Pagano & Ricardo Reis & Tano Santos & David Thesmar & Stijn Van Nieuwerburgh & Dimitri Vayanos, 2016. "The Sovereign-Bank Diabolic Loop and ESBies," American Economic Review, American Economic Association, pages 508-512.
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    19. Matteo Crosignani, 2015. "Why Are Banks Not Recapitalized During Crises?," Working Papers 203, Oesterreichische Nationalbank (Austrian Central Bank).
    20. Faia, Ester, 2017. "Sovereign risk, bank funding and investors’ pessimism," Journal of Economic Dynamics and Control, Elsevier, pages 79-96.
    21. Irina Balteanu & Aitor Erce, 2017. "Linking Bank Crises and Sovereign Defaults: Evidence from Emerging Markets," Working Papers 22, European Stability Mechanism.
    22. Puriya Abbassi & Falk Brauning & Falko Fecht & José-Luis Peydró, 2017. "International financial integration, crises and monetary policy: evidence from the Euro area interbank crises," Working Papers 965, Barcelona Graduate School of Economics.
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    More about this item

    Keywords

    bailouts; feedback loop; shared supervision; sovereign and corporate spreads; sovereign default;

    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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