The Economics of Sovereign Debt, Bailouts, and the Eurozone Crisis

TheEconomicsofSovereignDebt,Bailouts,andtheEurozoneCrisis Pierre-OlivierGourinchas,PhilippeMartin,andToddMesser WP/23/177 IMFWorkingPapersdescriberesearchinprogressbytheauthor(s)andarepublishedtoelicitcommentsandtoencouragedebate. TheviewsexpressedinIMFWorkingPapersarethoseoftheauthor(s)anddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement. 2023 AUG ©2023InternationalMonetaryFundWP/23/177 IMFWorkingPaper* ResearchDepartment TheEconomicsofSovereignDebt,Bailouts,andtheEurozoneCrisisPreparedbyPierre-OlivierGourinchas,PhilippeMartin,andToddMesser AuthorizedfordistributionbyPierre-OlivierGourinchas August2023 IMFWorkingPapersdescriberesearchinprogressbytheauthor(s)andarepublishedtoelicitcommentsandtoencouragedebate.TheviewsexpressedinIMFWorkingPapersarethoseoftheauthor(s)anddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement. ABSTRACT:Despiteaformal‘no-bailoutclause,’weestimatesignificantnetpresentvaluetransfersfromtheEuropeanUniontoCyprus,Greece,Ireland,Portugal,andSpain,rangingfromroughly0.5% (Ireland)toawhopping43%(Greece)of2010outputduringtheEurozonecrisis.Weproposeamodeltoanalyzeandunderstandbailoutsinamonetaryunion,andthelargeobserveddifferencesacrosscountries.Wecharacterizebailoutsizeandlikelihoodasafunctionoftheeconomicfundamentals(economicactivity,debt-to-gdpratio,defaultcosts).Ourmodelembedsa‘Southernview’ofthe crisis(transfersdidnothelp)anda‘Northernview’(transfersweakenfiscaldiscipline).Whileastrongerno-bailoutcommitmentreducesrisk-shifting,itmaynotbeoptimalfromtheperspectiveofthecreditorcountry,evenex-ante,ifitincreasestheriskofimmediateinsolvencyforhighdebtcountries.Hence,themodelprovidesapotentialjustificationfortheoftendecriedpolicyof‘kicking thecandowntheroad.’Mappingthemodeltotheestimatedtransfers,wefindthatthemainpurposeoftheoutsizedGreekbailoutwastopreventanexitfromtheeurozoneandpossiblecontagion. Bailoutstoavoidsovereigndefaultwerecomparativelymodest. JELClassificationNumbers: G15,F34,F45 Keywords: Euroarea;MonetaryUnion;Sovereigndebt;bailouts Author’sE-MailAddress: pgourinchas@imf.org,philippe.martin@sciencespo.fr,todd.e.messer@frb.gov *TheworkingpaperpublishedbyFED,NBERandCBERandcanbefoundat:FED NBERCEPR WORKINGPAPERS TheEconomicsofSovereignDebt,Bailouts,andtheEurozoneCrisis PreparedbyPreparedbyPierre-OlivierGourinchas,PhilippeMartin,andToddMesser1 1WethankPhilippeAghion,JavierBianchi(discussant),DanielCohen(discussant),GitaGopinath,AlbertoMartin(discussant),DirkNiepeltandJerominZettelmeyerforinsightfuldiscussionsaswellasseminarparticipantsatCEPR-ESSIM, NBER-IFM,theFederalReserveBankofDallas-UniversityofHouston-BancodeMexico3rdInternationalConferenceonInternationalEconomics,BanquedeFrance,StockholmUniversity,UniversityofOslo,IESEBusinessSchool,BostonCollege, UniversityofMichigan,UCRiverside,Columbia.ThefirstdraftofthispaperwaswrittenwhileP-O.GourinchaswasvisitingHarvardUniversity,whosehospitalityisgratefullyacknowledged.WethanktheFondationBanquedeFranceandtheBanquedeFrance-SciencesPopartnershipforitsfinancialsupport.WeareparticularlygratefultoAitorErceforhiscommentsandhelponthedataonofficialloans.Theviewsinthispaperaretheresponsibilityoftheauthorsanddonot necessarilyrepresentthoseoftheFederalReserveBoard,theFederalReserveSystem,theIMF,itsExecutiveBoard,orIMFManagement. 1Introduction. ‘ThemarketsaredeludingthemselveswhentheythinkatacertainpointtheothermemberstateswillputtheirhandsontheirwalletstosaveGreece.’ ECBExecutiveBoardmember,Ju´rgenStark(Reuters,2010,January10) ‘Theeuro-regiontreatiesdon’tforeseeanyhelpforinsolventcountries,butinrealitytheotherstateswouldhavetorescuethoserunningintodifficulty.’ GermanfinanceministerPeerSteinbrueck(TheFinancialTimes,2009,February18) ‘No,Greecewillnotdefault.Please.Intheeuroarea,thedefaultdoesnotexist.’ EconomicsCommissionerJoaquinAlmunia(Reuters,2009,January29) AstheEurozonecrisisof2010-2015highlighted,apotentialdefaultongovernmentdebtwithinamon-etaryunioncomprisedofsovereignmembersinvolvesuniquefeaturesthataffectthepotentialcostsandbenefitstodebtorandcreditorcountries.Amonetaryunionfacilitatesfinancialintegration.Withlargewithin-unioncross-borderholdingsoffinancialassets,includinggovernmentdebtheldbybanks,theexposureofcreditorcountriesinsidetheuniontosovereignriskishigh.Inaddition,monetaryandeconomicunionsusuallygohandinhand,fosteringrealintegration.Shouldacountryexperienceaseverefiscalcrisis,thishasthepotentialtodisproportionatelydisruptitstradingpartnersinsidetheunion.Further,asovereigndefaultcouldbethefirststeptowardsapotentialexitfromthemonetaryunion,potentiallyimpairingthecredibilityofothermembersorofthemonetaryunionasawhole.Forcreditorcountriesinsidetheunion,thereissignificantdirectandindirectexposureifafiscallyweakmemberdefaults. Shouldthesecostsforthegroupofcreditorcountriesexceedtheresourcesthedebtorcountryneedstoavoidadefault,aunilateraltransfer-intheformofabailout-mightbeapreferredoutcomefortheunion,helpingtoachieve(ex-post)efficiency.Itfollowsthatamonetaryunion,throughthedirectandcolla