Abstract
Abstract We study how cross-country macroeconomic spillovers caused by sovereign default affect equilibrium bailouts. Because of portfolio diversification, the default of one country causes a macroeconomic contraction in other countries, which motivates a bailout. But why do creditor countries choose to bailout debtor countries instead of their own private sector? We show that this is because an external bailout could be cheaper than a domestic bailout. We also show that although anticipated bailouts lead to higher borrowing, they can be Pareto improving not only ex post (after a country has defaulted) but also ex ante (before the country chooses its debt).
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