On the International Spillover Effects of Country-Specific Financial Sector Bailouts and Sovereign Risk Shocks

Abstract

We use sign-identified macroeconomic models to study the interaction of financial sector and sovereign credit risks in Europe. We find that country-specific financial sector bailout shocks do not generate strong international spillovers, because they primarily transfer private sector risk onto the local sovereign. By contrast, sovereign risk shocks generate substantial spillovers onto the global financial sector and for international sovereign debt markets. We conclude that any financial sector bailout policy that undermines the creditworthiness of the affected sovereign is likely to exacerbate global credit risk. Our findings highlight the unintended global consequences of country-specific financial sector bailout programmes.

Keywords: Financial sector bailouts; sovereign risk shocks; international spillovers; structural shocks; sign restrictions

JEL Classification: C58, E61, F42, GOl