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A Positive Framework to Analyze Sovereign Bail-outs within the EMU

Author

Listed:
  • Christian Fahrholz

    () (School of Economics and Business Administration, Friedrich-Schiller-University Jena)

  • Cezary Wójcik

Abstract

We propose a positive formal framework for analyzing sovereign bail-outs in the context of the European Monetary Union (EMU) with a view to making policy recommendations regarding improvements to the EMU institutional architecture. We build our analysis on a political economic game-theoretic model that allows tracing analytically the dynamics of the political process as well as the conditions and parameters on which the scope and limits of the bail-outs depend. In doing so, we formally take account of the negative externality' problem that has been central to policy debates related to the EMU's institutional design and has played an important role in the recent crisis. Contrary to the existing literature, we do not only focus on the economic aspects of such a negative externality, but also look at where they emanate from and interact with the dynamics of the political formation within the EMU. The analysis suggests that, under the present political-economic set-up of the EMU, the bail-outs were inevitable, i.e. a threat of default by one member must, under identifiable conditions, result in sharing the costs of fiscal adjustment by the rest of the members.

Suggested Citation

  • Christian Fahrholz & Cezary Wójcik, 2011. "A Positive Framework to Analyze Sovereign Bail-outs within the EMU," Global Financial Markets Working Paper Series 15-2011, Friedrich-Schiller-University Jena.
  • Handle: RePEc:hlj:hljwrp:15-2011
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    Cited by:

    1. Torój, Andrzej & Bednarek, Elżbieta & Bęza-Bojanowska, Joanna & Osińska, Joanna & Waćko, Katarzyna & Witkowski, Dariusz, 2012. "EMU: the (post-)crisis perspective. Literature survey and implications for the euro-candidates," MF Working Papers 12, Ministry of Finance in Poland, revised 06 Mar 2012.

    More about this item

    Keywords

    Sovereign debt crisis; bail-out; negative externality; political economics; game theory; euro; EMU;

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • H77 - Public Economics - - State and Local Government; Intergovernmental Relations - - - Intergovernmental Relations; Federalism
    • C70 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - General

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