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

S.C.W. Eijffinger, M.L. Kobielarz, R.B. Uras

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Abstract

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.
Original languageEnglish
Place of PublicationTilburg
PublisherEconomics
Number of pages23
Volume2015-018
Publication statusPublished - 5 Mar 2015

Publication series

NameCentER Discussion Paper
Volume2015-018

Keywords

  • EMU
  • sovereign debt crisis
  • contagion
  • bail-out
  • interest rate spread

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    Eijffinger, S. C. W., Kobielarz, M. L., & Uras, R. B. (2015). Sovereign Debt, Bail-Outs and Contagion in a Monetary Union. (CentER Discussion Paper; Vol. 2015-018). Economics.