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Sovereign Bailouts: Are Ex-Ante Conditions Useful?

Perazzi, Elena (2022): Sovereign Bailouts: Are Ex-Ante Conditions Useful?

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Bailout guarantees create moral hazard, even when full repayment can be enforced. In a strategic default model calibrated to the GIIPS countries, I show that, with unconditional bailout guarantees, government deficits are 6 to 15 percentage points higher than they would be in the absence of guarantees, for a given level of debt. Even if the frequency of outright defaults is reduced, this results in a high frequency of bailouts, which may be inefficient if providing a bailout is costly. In this case ex-ante fiscal conditions can be an effective way to make bailouts a time-consistent policy. The model provides a rationale to a recent reform of the European Stability Mechanism (ESM).

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