When Do Currency Unions Benefit from Default?

89 Pages Posted: 11 Nov 2019

See all articles by Xuan Wang

Xuan Wang

University of Oxford - Said Business School; University of Oxford

Date Written: November 4, 2019

Abstract

Since the Eurozone Crisis of 2010-12, a key debate on the viability of a currency union has focused on the role of a fiscal union in adjusting for country heterogeneity. However, a fully-fledged fiscal union may not be politically feasible. This paper develops a two-country international finance model to examine the benefits of the bankruptcy code of a capital markets union - in the absence of a fiscal union - as an alternative financial mechanism to improve the welfare of a currency union. When domestic credit risks are present, I show that a lenient union-wide bankruptcy code that allows for default in the cross-border capital markets union leads to a Pareto improvement within the currency union. However, if the union-wide bankruptcy code is too lenient, default may cause the collapse of the capital markets union and impede cross-border risk sharing. Moreover, the absence of floating exchange rates removes a mechanism to neutralise domestic credit risks; I show that softening the union-wide bankruptcy code can recoup the lost benefits of floating nominal exchange rates. The model provides the economic and welfare implications of bankruptcy within a capital markets union in the Eurozone.

Keywords: default, bankruptcy code, fiscal union, capital markets union, bank credit, inside money, price-level and exchange rate determinacy, liquidity intermediary asset pricing

JEL Classification: E64, F55, G37, G43

Suggested Citation

Wang, Xuan, When Do Currency Unions Benefit from Default? (November 4, 2019). Saïd Business School WP 2019-15. Available at SSRN: https://ssrn.com/abstract=3481719 or http://dx.doi.org/10.2139/ssrn.3481719

Xuan Wang (Contact Author)

University of Oxford - Said Business School ( email )

Park End Street
Oxford, OX1 1HP
Great Britain

University of Oxford ( email )

Mansfield Road
Oxford, Oxfordshire OX1 4AU
United Kingdom

HOME PAGE: http://https://sites.google.com/view/xuan-wang

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