Welfare gains of bailouts in a sovereign default model

Arbeitspapier

We examine the welfare effects of bailouts in economies exposed to sovereign default risk. When a government of a small open economy requests a bailout from an international financial institution, it receives a non-defaultable loan of size G that comes with imposed debt limits. The government endogenously asks for the bailout during recessions and repays it when the economy recovers. Hence, the bailout acts as an imperfect state contingent asset that makes the economy better off. The bailout duration is endogenous and increases with its size. The bailout size creates non-trivial tradeoffs between receiving a larger amount of relatively cheap resources precisely in times of need on the one hand, and facing longer-lasting financial constraints and accumulated interest payments, on the other hand. We characterize and quantify these tradeoffs and document that welfare gains of bailouts are hump-shaped in the size of bailout loans.

Object Details

• ISBN: 978-952-323-307-2
• Language: Englisch

References and Relationships

• Bibliographic citation: Series: Bank of Finland Research Discussion Papers ; No. 25/2019

Classification and Topics

• Classification: Wirtschaft ; Financial Markets and the Macroeconomy ; Current Account Adjustment; Short-term Capital Movements ; International Lending and Debt Problems

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Pancrazi, Roberto ; Seoane, Hernán D. ; Vukotic, Marija
• Event: Veröffentlichung
• (who): Bank of Finland
• (where): Helsinki
• (when): 2019

Further information

• Handle: http://hdl.handle.net/10419/212459
• Last update: 10.03.2025, 11:42 AM CET