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Country Solidarity, Private Sector Involvement and the Contagion of Sovereign Crises

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  • Tirole, Jean
Abstract
Classic analyses of sovereign debt make no predictions concerning the allocation of risk between the market and the official sector or among official sector creditors. To open the black box of the composition of a sovereign's foreign liabilities, this paper develops a new framework and distinguishes between ``ex-post solidarity'', aimed at avoiding collateral damages inflicted by a distressed country's default, and ``contractual solidarity'', illustrated by joint-and-several liability or lines of credit, that creates formal modes of insurance. When countries differ substantially in their probability of distress, the optimal mechanism takes the form of a debt brake together with mixed public-private financing for the weaker country; no joint liability emerges. By contrast, in a more symmetrical, mutual-insurance context, contractual solidarity in the form of joint liability is optimal provided that country shocks are sufficiently independent and spillovers costs sufficiently large relative to default costs. Joint liability increases both borrowing capability and the risk of contagion. Spillovers, when endogenized, are larger under mutual insurance than under one-way insurance. Finally, the paper considers the possibility of debt monetization, comparing the outcomes under a currency union and an own currency. It studies whether a currency area is more conducive to bailouts and whether bailouts are optimally denominated in domestic or foreign currency.

Suggested Citation

  • Tirole, Jean, 2012. "Country Solidarity, Private Sector Involvement and the Contagion of Sovereign Crises," IDEI Working Papers 761, Institut d'Économie Industrielle (IDEI), Toulouse, revised Sep 2012.
    • Handle: RePEc:ide:wpaper:26016
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    References listed on IDEAS

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    Cited by:

    1. Dirk Niepelt & Harris Dellas, 2013. "Credibility For Sale," 2013 Meeting Papers 12, Society for Economic Dynamics.
    2. Giancarlo Corsetti & Luca Dedola, 2016. "The Mystery Of The Printing Press: Monetary Policy And Self-Fulfilling Debt Crises," Journal of the European Economic Association, European Economic Association, vol. 14(6), pages 1329-1371, December.
    3. Michiel Bijlsma & Shahin Vallée, 2012. "The creation of euro area financial safety nets," Working Papers 732, Bruegel.
    4. André Lucas & Bernd Schwaab & Xin Zhang, 2014. "Conditional Euro Area Sovereign Default Risk," Journal of Business & Economic Statistics, Taylor & Francis Journals, vol. 32(2), pages 271-284, April.
    5. Lane, Philip, 2013. "Capital Flows in the Euro Area," CEPR Discussion Papers 9493, C.E.P.R. Discussion Papers.
    6. Basu , Kaushik & Stiglitz, Joseph E., 2013. "International lending, sovereign debt and joint liability : an economic theory model for amending the treaty of Lisbon," Policy Research Working Paper Series 6555, The World Bank.
    7. Jean Tirole, 2015. "Country Solidarity in Sovereign Crises," American Economic Review, American Economic Association, vol. 105(8), pages 2333-2363, August.
    8. Philip R. Lane, 2013. "Growth And Adjustment Challenges For The Euro Area," The Economic and Social Review, Economic and Social Studies, vol. 44(2), pages 273-295.
    9. Giancarlo Corsetti & Luca Dedola, 2012. "The "Mystery of the Printing Press" Monetary Policy and Self-fulfilling Debt Crises," Discussion Papers 1424, Centre for Macroeconomics (CFM), revised Aug 2014.
    10. Schwaab, Bernd & Lucas, André & Zhang, Xin, 2013. "Conditional and joint credit risk," Working Paper Series 1621, European Central Bank.
    11. Saleem Bahaj, 2014. "Systemic Sovereign Risk: Macroeconomic Implications in the Euro Area," Discussion Papers 1406, Centre for Macroeconomics (CFM).
    12. Gros, Daniel, 2012. "A simple model of multiple equilibria and sovereign default," CEPS Papers 7174, Centre for European Policy Studies.
    13. Tyrole, J., 2012. "The euro crisis: some reflexions on institutional reform," Financial Stability Review, Banque de France, issue 16, pages 225-242, April.
    14. Fabrice Collard & Michel Habib & Jean-Charles Rochet, 2015. "Sovereign Debt Sustainability In Advanced Economies," Journal of the European Economic Association, European Economic Association, vol. 13(3), pages 381-420, June.

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    More about this item

    Keywords

    Sovereign debt; joint liability; bailouts; contagion; private sector involvement; debt monetization;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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