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Speculative Attacks within or outside a Monetary Union: Default versus Inflation (what to do today)

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  • Gros, Daniel

Abstract

In this analytical policy brief, CEPS Director Daniel Gros explores whether there is a fundamental difference between a formal sovereign default with a haircut and debt monetisation, which reduces the purchasing power for investors by the same amount. He argues that there is indeed a difference because a formal sovereign default invariably leads to a banking crisis. Moreover, within a monetary union a sovereign is more exposed to liquidity problems than a country with an independent currency and any of its problems quickly spill over into the banking system, which cannot survive without a reliable source of liquidity given that banks are by nature highly leveraged institutions. In terms of policy prescriptions, one conclusion is that less effort and financing should be devoted to trying to lower yields on peripheral government debt, but a lender of last resort is needed for both sovereigns and the banks. Another policy priority should be to stabilise the banking system in such a way that it can survive even if government debt yields increase.

Suggested Citation

  • Gros, Daniel, 2011. "Speculative Attacks within or outside a Monetary Union: Default versus Inflation (what to do today)," CEPS Papers 6359, Centre for European Policy Studies.
  • Handle: RePEc:eps:cepswp:6359
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    File URL: http://www.ceps.eu/system/files/book/2011/11/DG%20on%20Speculative%20Attacks.pdf
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    References listed on IDEAS

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    1. Adrian, Tobias & Gros, Daniel, 1999. "A Stochastic Model of Self-Fulfilling Crises in Fixed Exchange Rate Systems," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 4(2), pages 129-146, April.
    2. Obstfeld, Maurice, 1996. "Models of currency crises with self-fulfilling features," European Economic Review, Elsevier, vol. 40(3-5), pages 1037-1047, April.
    3. Obstfeld, Maurice, 1986. "Rational and Self-fulfilling Balance-of-Payments Crises," American Economic Review, American Economic Association, vol. 76(1), pages 72-81, March.
    4. Francesco Giavazzi & Marco Pagano, 1995. "Non-Keynesian Effects of Fiscal Policy Changes: International Evidence and the Swedish Experience," NBER Working Papers 5332, National Bureau of Economic Research, Inc.
    5. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
    6. De Grauwe, Paul, 2011. "Governance of a Fragile Eurozone," CEPS Papers 5523, Centre for European Policy Studies.
    7. Sachs, Jeffrey & Tornell, Aaron & Velasco, Andres, 1995. "The Collapse of the Mexican Peso: What Have We Learned?," Working Papers 95-22, C.V. Starr Center for Applied Economics, New York University.
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    Cited by:

    1. Jean Pisani-Ferry, 2012. "The Euro crisis and the new impossible trinity," Policy Contributions 674, Bruegel.
    2. repec:eee:macchp:v2-2305 is not listed on IDEAS
    3. Gros, Daniel, 2014. "The EMS Crisis of the 1990s: Parallels with the present crisis?," CEPS Papers 9119, Centre for European Policy Studies.

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