IMF Economic Review

, Volume 66, Issue 4, pp 665–693 | Cite as

Dealing with Systemic Sovereign Debt Crises: Fiscal Consolidation, Bail-Ins, or Bail-Outs?

  • Damiano SandriEmail author
Research Article


The paper presents a tractable model to understand how international financial institutions (IFIs) should deal with the sovereign debt crisis of a systemic country, in which case private creditors’ bail-ins entail international spillovers. We use the model to solve for the optimal combination between fiscal consolidation, bail-ins, and bail-outs to restore debt sustainability. For non-systemic countries, only fiscal consolidation and bail-ins should be used, based on an ex-post assessment of their relative costs. Systemic crises raise significant new challenges. First, to reduce the spillovers associated with bail-ins, IFIs should be able to provide bail-outs. Second, to contain the moral hazard effects of bail-outs, IFIs should operate under a binding crisis-resolution framework that limits the provision of bail-outs to highly systemic countries, coupled with more stringent fiscal consolidation requirements.

JEL Classification

F33 F34 F4 

Supplementary material


  1. Acemoglu, Daron, Asuman Ozdaglar, and Alireza Tahbaz-Salehi. 2015. Systemic Risk and Stability in Financial Networks. The American Economic Review 105(2): 564–608.CrossRefGoogle Scholar
  2. Aguiar, Mark, and Gita Gopinath. 2006. Defaultable Debt, Interest Rates and the Current Account. Journal of International Economics 69(1): 64–83.CrossRefGoogle Scholar
  3. Alter, Adrian, and Andreas Beyer. 2014. The Dynamics of Spillover Effects During the European Sovereign Debt Turmoil. Journal of Banking and Finance 42: 134–153.CrossRefGoogle Scholar
  4. Arellano, Cristina. 2008. Default Risk and Income Fluctuations in Emerging Economies. American Economic Review 98(3): 690–712.CrossRefGoogle Scholar
  5. Arghyrou, Michael G., and Alexandros Kontonikas. 2012. The EMU Sovereign-Debt Crisis: Fundamentals, Expectations and Contagion. Journal of International Financial Markets, Institutions and Money 22(4): 658–677.CrossRefGoogle Scholar
  6. Barro, Robert. 1998. The IMF Doesn’t Put Out Fires, it Starts Them. Business Week, December 7.Google Scholar
  7. Beirne, John, and Marcel Fratzscher. 2013. The Pricing of Sovereign Risk and Contagion During the European Sovereign Debt Crisis. Journal of International Money and Finance 34: 60–82.CrossRefGoogle Scholar
  8. Borensztein, Eduardo. 1990. Debt Overhang, Credit Rationing and Investment. Journal of Development Economics 32(2): 315–335.CrossRefGoogle Scholar
  9. Boz, Emine. 2011. Sovereign Default, Private Sector Creditors, and the IFIs. Journal of International Economics 83: 70–82.CrossRefGoogle Scholar
  10. Cabrales, Antonio, Piero Gottardi, and Fernando Vega-Redond. 2014. Bilateral Exposures and Systemic Solvency Risk. CESifo Working Paper No. 4715.Google Scholar
  11. Caceres, Carlos, Vincenzo Guzzo, and Miguel Segoviano. 2010. Sovereign Spreads: Global Risk Aversion, Contagion or Fundamentals. IMF Working Paper 10/120.Google Scholar
  12. Calomiris, Charles. 1998. The IMF’s Imprudent Role as Lender of Last Resort. Cato Journal 17(3): 275–294.Google Scholar
  13. Claessens, Stijn, and Ishac Diwan. 1990. Investment Incentives: New Money, Debt Relief, and the Critical Role of Conditionality in the Debt Crisis. The World Bank Economic Review 4(1): 21–41.CrossRefGoogle Scholar
  14. Constâncio, Vítor. 2012. Contagion and the European Debt Crisis. Financial Stability Review 16: 109–121.Google Scholar
  15. Cordella, Tito, and Eduardo Levy Yeyati. 2005. Country Insurance. IMF Staff Papers 52: 85–106.Google Scholar
  16. Corsetti, Giancarlo, Bernardo Guimaraes, and Nouriel Roubini. 2006. International Lending of Last Resort and Moral Hazard: A Model of IMF’s Catalytic Finance. Journal of Monetary Economics 53(3): 441–471.CrossRefGoogle Scholar
  17. De Bruyckere, Valerie, Maria Gerhardt, Glenn Schepens, and Rudi Vander Vennet. 2013. Bank/Sovereign Risk Spillovers in the European Debt Crisis. Journal of Banking and Finance 37(12): 4793–4809.CrossRefGoogle Scholar
  18. De Santis, Roberto A. 2012. The Euro Area Sovereign Debt Crisis: Save Haven, Credit Rating Agencies and the Spread of the Fever from Greece, Ireland and Portugal. ECB Working Paper No. 1419.Google Scholar
  19. De Santis, Roberto A., and Srečko Zimic. 2017. Spillovers Among Sovereign Debt Markets: Identification by Absolute Magnitude Restrictions. ECB Working Paper No. 2055.Google Scholar
  20. Dovis, Alessandro, and Rishabh Kirpalani. 2018. Reputation, Bailouts, and Interest Rate Spread Dynamics. Working Paper.Google Scholar
  21. Eaton, Jonathan, and Mark Gersovitz. 1981. Debt with Potential Repudiation: Theoretical and Empirical Analysis. Review of Economic Studies 48(2): 289–309.CrossRefGoogle Scholar
  22. Elliott, Matthew, Benjamin Golub, and Matthew O. Jackson. 2014. Financial Networks and Contagion. American Economic Review 104(10): 3115–3153.CrossRefGoogle Scholar
  23. Fink, Fabian, and Almuth Scholl. 2016. A Quantitative Model of Sovereign Debt, Bailouts and Conditionality. Journal of International Economics 98: 176–190.CrossRefGoogle Scholar
  24. Glasserman, Paul, and H. Peyton Young. 2016. Contagion in Financial Networks. Journal of Economic Literature 54(3): 779–831.CrossRefGoogle Scholar
  25. Gourieroux, Christian, J.-C. Héam, and Alain Monfort. 2012. Bilateral Exposures and Systemic Solvency Risk. Canadian Journal of Economics 45(4): 1273–1309.CrossRefGoogle Scholar
  26. Jeanne, Olivier, and Jeromin Zettelmeyer. 2005. The Mussa Theorem (and Other Results on IMF-Induced Moral Hazard). IMF Staff Papers 52(si): 64–84.Google Scholar
  27. Jeanne, Olivier, Jonathan D. Ostry, and Jeromin Zettelmeyer. 2008. A Theory of International Crisis Lending and IMF Conditionality. IMF Working Papers No. 08/236, 1–33.Google Scholar
  28. Juessen, Falko, and Andreas Schabert. 2013. Fiscal Policy, Sovereign Default, and Bailouts. IZA Discussion Paper No. 7805.Google Scholar
  29. Kirsch, Florian, and Ronald Rühmkorf. 2015. Sovereign Borrowing, Financial Assistance, and Debt Repudiation. Economic Theory 64(4): 777–804.Google Scholar
  30. Krugman, Paul. 1988. Financing vs. Forgiving a Debt Overhang. Journal of Development Economics 29(3): 253–268.CrossRefGoogle Scholar
  31. Ludwig, Alexander. 2014. A Unified Approach to Investigate Pure and Wake-Up-Call Contagion: Evidence from the Eurozone’s First Financial Crisis. Journal of International Money and Finance 48: 125–146.CrossRefGoogle Scholar
  32. Meltzer Commission. 2000. Report of the International Financial Institutions Advisory Commission.Google Scholar
  33. Mendoza, Enrique G., and Vivian Z. Yue. 2012. A General Equilibrium Model of Sovereign Default and Business Cycles. The Quarterly Journal of Economics 127(2): 889–946.CrossRefGoogle Scholar
  34. Morris, Stephen, and Hyun Song Shin. 2006. Catalytic Finance: When Does it Work? Journal of International Economics 70(1): 161–177.CrossRefGoogle Scholar
  35. Müller, Andreas, Kjetil Storesletten, and Fabrizio Zilibotti. 2015. Sovereign Debt and Structural Reforms. CEPR Discussion Paper No. 10588.Google Scholar
  36. Pancrazi, Roberto, Hernan D. Seoane, and Marija Vukotic. 2016. Sovereign Risk, Private Credit, and Stabilization Policies. Mimeo.Google Scholar
  37. Pitchford, Rohan, and Mark L.J. Wright. 2012. Holdouts in Sovereign Debt Restructuring: A Theory of Negotiation in a Weak Contractual Environment. The Review of Economic Studies 79(2): 812–837.CrossRefGoogle Scholar
  38. Wright, Mark L.J. 2005. Coordinating Creditors. The American Economic Review 95(2): 388–392.CrossRefGoogle Scholar

Copyright information

© International Monetary Fund 2018

Authors and Affiliations

  1. 1.International Monetary FundWashingtonUSA

Personalised recommendations