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

Tirole, Jean (2012) Country Solidarity, Private Sector Involvement and the Contagion of Sovereign Crises. , Toulouse

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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.

Item Type: Monograph (Working Paper)
Language: English
Date: June 2012
Place of Publication: Toulouse
Uncontrolled Keywords: Sovereign debt, joint liability, bailouts, contagion, private sector involvement, debt monetization
JEL codes: E62 - Fiscal Policy; Public Expenditures, Investment, and Finance; Taxation
F34 - International Lending and Debt Problems
H63 - Debt; Debt Management
Divisions: TSE-R (Toulouse)
Institution: Université Toulouse 1 Capitole
Site: UT1
Date Deposited: 09 Jul 2014 17:32
Last Modified: 12 Apr 2018 09:42

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