Exit Expectations and Debt Crises in Currency Unions

59 Pages Posted: 16 Sep 2015

See all articles by Alexander Kriwoluzky

Alexander Kriwoluzky

Martin Luther University of Halle-Wittenberg

Gernot J. Müller

University of Tuebingen - Department of Economics

Martin Wolf

University of Bonn

Date Written: September 2015

Abstract

Membership in a currency union is not irreversible. Expectations of exit may emerge during a sovereign debt crisis, because by exiting countries can redenominate and reduce their liabilities. This possibility alters the dynamics of sovereign debt crises. We establish this formally within a small open economy model of changing policy regimes. The model permits explosive dynamics of debt and sovereign yields inside the currency union and allows us to distinguish between exit expectations and those of an outright default. By estimating the model on Greek data, we quantify the contribution of exit expectations to the crisis dynamics during 2009-2012.

Keywords: currency union, euro crisis, exit, fiscal policy, redenomination premium, regime-switching model, sovereign debt crisis

JEL Classification: E41, E52, E62

Suggested Citation

Kriwoluzky, Alexander and Müller, Gernot J. and Wolf, Martin, Exit Expectations and Debt Crises in Currency Unions (September 2015). CEPR Discussion Paper No. DP10817, Available at SSRN: https://ssrn.com/abstract=2661546

Alexander Kriwoluzky (Contact Author)

Martin Luther University of Halle-Wittenberg ( email )

Emil-Abderhalden-Str. 7
Halle an der Saale
06099 Halle (Saale), DE Sachsen-Anhalt 06099
Germany

Gernot J. Müller

University of Tuebingen - Department of Economics ( email )

Mohlstrasse 36
D-72074 Tuebingen, 72074
Germany

Martin Wolf

University of Bonn ( email )

Regina-Pacis-Weg 3
Postfach 2220
Bonn, D-53012
Germany

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