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Banking and Sovereign Debt Crises in Monetary Union Without Central Bank Intervention

Jin Cheng (), Meixing Dai () and Frédéric Dufourt ()

Working Papers of BETA from Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg

Abstract: We propose a model to analyze the conditions of emergence of a twin banking and sovereign debt crisis in a monetary union with an institutional framework which is broadly similar to the Eurozone at the onset of the financial crisis. We show that when the responsibility of rescuing the banking system is entirely ascribed to domestic governments - in particular because the central bank is not allowed to intervene as a lender of last resort on sovereign bond markets - the main tool to fight against a systemic banking crisis (the financial safety net) may aggravate, instead of mitigate, the solvency problems of banks and of the government. Depending on investors' expectations, the banking system and the government may either survive a negative financial shock or fail together. In this context of negative self-fulfilling expectations, we also analyze the role of credit rating agencies as potential catalysts to the crisis, we emphasize possible contagion effects to "healthy" member states through the banking system, and we discuss proposed policy options like the creation of "Eurobonds" to avoid the resurgence of such crises.

Keywords: banking crisis; sovereign debt crisis; bank runs; financial safety net; liquidity regulation; government deposit guaranteen self fulfilling propheties. (search for similar items in EconPapers)
JEL-codes: E43 F31 F34 F4 G2 (search for similar items in EconPapers)
Date: 2014
New Economics Papers: this item is included in nep-ban, nep-mac and nep-mon
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Related works:
Journal Article: Banking and sovereign debt crises in a monetary union without central bank intervention (2017) Downloads
Working Paper: Banking and sovereign debt crises in a monetary union without central bank intervention (2017)
Working Paper: Banking and Sovereign Debt Crises in a Monetary Union Without Central Bank Intervention (2014) Downloads
Working Paper: Banking and Sovereign Debt Crises in a Monetary Union Without Central Bank Intervention (2014) Downloads
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