Sovereign debt, bail‐outs and contagion in a monetary union 

(CEPR heeft onze studie gepubliceerd, zie hieronder)


The European sovereign debt crisis is characterized by the simultaneous surge in borrowing
costs in the GIPS countries after 2008. We present a theory, which can account for the
behavior of sovereign bond spreads in Southern Europe between 1998 and 2012. Our key
theoretical argument is related to the bail‐out guarantee provided by a monetary union,
which endogenously varies with the number of member countries in sovereign debt trouble.

We incorporate this theoretical foundation in an otherwise standard small open economy
DSGE model and explain (i) the convergence of interest rates on sovereign bonds following
the European monetary integration in late 1990s, and (ii) ‐ following the heightened default
risk of Greece ‐ the sudden surge in interest rates in countries with relatively sound
economic and financial fundamentals. We calibrate the model to match the behavior of the
Portuguese economy over the period of 1998 to 2012.

JEL Classification: F33, F34, F36 and F41
Keywords: bail‐out, contagion, interest rate spreads and sovereign debt crisis
Sylvester C. W. Eijffinger
CentER and EBC, Tilburg University and CEPR
Michal L. Kobielarz
CentER and EBC, Tilburg University
Burak R. Uras
CentER and EBC, Tilburg University

(CEPR march 2015 001 DP10459, pdf)

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