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Resolving sovereign debt crises: Opening or closing the tap?

  • Kohler, Wilhelm
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    This paper first describes the ingredients the present crisis in the euro zone and then evaluates the key options that policy makers face in resolving the crisis and avoiding similar crises in the future. I argue that the crisis should not be seen as caused by government profligacy alone. In many troubled countries, an unsustainable build-up of private sector debt was involved as well. I argue that a more fundamental problem is that the euro zone lacks an adjustment mechanism for balance of payments crises that may arise in its member countries, with or without excessive government deficits. The metaphor of taps to be opened or closed by policy is used to discuss the core trade offs that policy makers face. I discuss monetary taps, bailout taps, austerity taps and devaluation taps. I propose a simple model of government bond markets with sovereign insolvency to be used in order to evaluate EU-type bailouts. I discuss the pros and cons of austerity as a precondition for such bailouts, and I criticize the use of Target2 as a mechanism to absorb balance of national payments crises.

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    File URL: http://econstor.eu/bitstream/10419/59507/1/717850269.pdf
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    Paper provided by University of Tuebingen, Faculty of Economics and Social Sciences in its series University of Tuebingen Working Papers in Economics and Finance with number 39.

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    Date of creation: 2012
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    Handle: RePEc:zbw:tuewef:39
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    1. De Grauwe, Paul, 2011. "Governance of a Fragile Eurozone," CEPS Papers 5523, Centre for European Policy Studies.
    2. Hogrefe, Jan & Jung, Benjamin & Kohler, Wilhelm K., 2012. "Putting currency misalignment into gravity: The currency union effect reconsidered," University of Tuebingen Working Papers in Economics and Finance 32, University of Tuebingen, Faculty of Economics and Social Sciences.
    3. Hans-Werner Sinn & Timo Wollmershäuser, 2011. "Target Loans, Current Account Balances and Capital Flows: The ECB’s Rescue Facility," CESifo Working Paper Series 3500, CESifo Group Munich.
    4. De Grauwe, Paul & Ji, Yuemei, 2012. "Mispricing of Sovereign Risk and Multiple Equilibria in the Eurozone," CEPS Papers 6548, Centre for European Policy Studies.
    5. Volker Grossmann, 2011. "Wirkungen und Nebenwirkungen des EU/IWF-Rettungsschirms für verschuldete Euroländer," Wirtschaftsdienst, Springer, vol. 91(3), pages 179-185, March.
    6. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, June.
    7. Daniel Leigh & Andrea Pescatori & Jaime Guajardo, 2011. "Expansionary Austerity New International Evidence," IMF Working Papers 11/158, International Monetary Fund.
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