Bailout dynamics in a monetary union

Abstract

The Eurozone bailouts consisted of credit lines with favorable lending conditions, equivalent to countries receiving implicit fiscal transfers. They are often interpreted as meant to prevent a default in the Eurozone or resolve the crisis. Contrary to this narrative, Greece defaulted on its debt and went through a deep and prolonged recession, despite receiving fiscal assistance. This paper analyzes country bailouts in a monetary union within a framework where sovereign default and exit from the union are two separate decisions. The studied bailouts prevent an exit and, thus, do not exclude subsequent defaults. The model replicates the experience of Greece and captures the coexistence of bailouts, defaults, and recession. It also sheds new light on the moral hazard discussion of bailouts by showing no significant effects from exit-driven bailouts.