Exit expectations and debt crises in currency unions

Abstract

We study a sovereign debt crisis in a small member state of a currency union. If the country exits the currency union, it may redenominate its liabilities and reduce the real value of debt through depreciation and inflation. We analyze formally how the anticipation of this possibility, “exit expectations”, impact the dynamics of the sovereign debt crisis. First, we show that public debt accumulates faster and sovereign yields increase more strongly because of redenomination risk. Second, we find that exit expectations induce public debt to be stagflationary. Last, we analyze Greek time-series data through the lens of our model and quantify the contribution of exit expectations to the Greek crisis.

Citation

Kriwoluzky, Alexander, Gernot J. Müller, and Martin Wolf (2019). “Exit Expectations and Debt Crises in Currency Unions.” Journal of International Economics 121: 103252

@article{KMW2019,
title = {Exit expectations and debt crises in currency unions},
author = {Alexander Kriwoluzky and Gernot J. Müller and Martin Wolf},
journal = {Journal of International Economics},
volume = {121},
pages = {103253},
year = {2019},
issn = {0022-1996},
doi = {https://doi.org/10.1016/j.jinteco.2019.103253},
keywords = {Currency union, Exit, Sovereign debt crisis, Fiscal policy, Redenomination risk, Euro crisis, Regime-switching model}}```