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Sovereign Debt, Bail-Outs and Contagion in a Monetary Union

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  • Eijffinger, S.C.W.

    (Tilburg University, Center For Economic Research)

  • Kobielarz, M.L.

    (Tilburg University, Center For Economic Research)

  • Uras, R.B.

    (Tilburg University, Center For Economic Research)

Abstract

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.
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Suggested Citation

  • Eijffinger, S.C.W. & Kobielarz, M.L. & Uras, R.B., 2015. "Sovereign Debt, Bail-Outs and Contagion in a Monetary Union," Discussion Paper 2015-018, Tilburg University, Center for Economic Research.
    • Handle: RePEc:tiu:tiucen:3a1338db-3d69-448b-92c0-85d57f44a988
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    Cited by:

    1. Heuver, Richard A. & Berndsen, Ron J., 2022. "Liquidity coverage ratio in a payment network: Uncovering contagion paths," Latin American Journal of Central Banking (previously Monetaria), Elsevier, vol. 3(1).
    2. van Riet, Ad, 2017. "Addressing the safety trilemma: a safe sovereign asset for the eurozone," ESRB Working Paper Series 35, European Systemic Risk Board.
    3. Michael Curran & Adnan Velic, 2020. "Interest rate volatility and macroeconomic dynamics: Heterogeneity matters," Review of International Economics, Wiley Blackwell, vol. 28(4), pages 957-975, September.
    4. van Riet, Ad, 2018. "Modern financial repression in the euro area crisis: making high public debt sustainable?," MPRA Paper 92649, University Library of Munich, Germany.
    5. Breckenfelder, Johannes & Schwaab, Bernd, 2018. "Bank to sovereign risk spillovers across borders: Evidence from the ECB’s Comprehensive Assessment," Journal of Empirical Finance, Elsevier, vol. 49(C), pages 247-262.
    6. Michael Patrick Curran & Adnan Velic, 2017. "Interest Rate Volatility And Macroeconomic Dynamics: A Cross-Country Analysis," Villanova School of Business Department of Economics and Statistics Working Paper Series 35, Villanova School of Business Department of Economics and Statistics.
    7. Niels Gilbert, 2019. "Euro area sovereign risk spillovers before and after the ECB's OMT announcement," DNB Working Papers 636, Netherlands Central Bank, Research Department.

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    More about this item

    Keywords

    EMU; sovereign debt crisis; contagion; bail-out; interest rate spread;
    All these keywords.

    JEL classification:

    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics

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