Resolving sovereign debt crises: Opening or closing the tap?

Wilhelm Kohler

No 39, University of Tübingen Working Papers in Business and Economics from University of Tuebingen, Faculty of Economics and Social Sciences, School of Business and Economics

Abstract: This paper first describes the ingredients the present crisis in the euro zone and then evaluates the key options that policy makers face in resolving the crisis and avoiding similar crises in the future. I argue that the crisis should not be seen as caused by government profligacy alone. In many troubled countries, an unsustainable build-up of private sector debt was involved as well. I argue that a more fundamental problem is that the euro zone lacks an adjustment mechanism for balance of payments crises that may arise in its member countries, with or without excessive government deficits. The metaphor of taps to be opened or closed by policy is used to discuss the core trade offs that policy makers face. I discuss monetary taps, bailout taps, austerity taps and devaluation taps. I propose a simple model of government bond markets with sovereign insolvency to be used in order to evaluate EU-type bailouts. I discuss the pros and cons of austerity as a precondition for such bailouts, and I criticize the use of Target2 as a mechanism to absorb balance of national payments crises.

Keywords: Euro; Sovereign risk; Sovereign default; Government solvency; Lender of last resort; External balance; Balance of payments (search for similar items in EconPapers)
JEL-codes: F33 F36 (search for similar items in EconPapers)
Date: 2012
New Economics Papers: this item is included in nep-eec and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:zbw:tuewef:39

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