SOVEREIGN DEBT CRISIS IN A MONETARY UNION: ACCOUNTING FOR EXCESSIVE DEBT, HOUSING BUBBLES, AND THE TRANSMISSION OF CRISES

Despite vast empirical documentation of the recent sovereign debt crisis in southern Europe, there is little research accounting for the following stylized facts in a single coherent framework: continuous borrowing, high growth, housing bubbles, and current account deficits since the beginning of th...

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Bibliographic Details
Published inEconomic inquiry Vol. 57; no. 2; pp. 1098 - 1119
Main Authors Kim, Yong Jin, Lee, Chul‐In
Format Journal Article
LanguageEnglish
Published Boston, USA Wiley Periodicals, Inc 01.04.2019
Western Economic Association International
Western Economic Association
Subjects
Accounting
Analysis
Borrowing
Contagion
Crises
Deficits
Documentation
Economic aspects
Economic models
European Monetary Union
Fiscal policy
Forecasts and trends
Growth models
Housing
Keynesian economics
Monetary unions
Moral hazard
National debt
Psychology
Public debt
Regulation
Sovereign debt
Vulnerability
United States
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Summary:Despite vast empirical documentation of the recent sovereign debt crisis in southern Europe, there is little research accounting for the following stylized facts in a single coherent framework: continuous borrowing, high growth, housing bubbles, and current account deficits since the beginning of the European Monetary Union ending with a sudden crisis and subsequent contagion of crisis. We fill this gap by proposing a model and fitting it to the data. Using a growth model with collateral constraints of small peripheral economies in the institution of a monetary union, we analyze the multilayer moral hazards underlying excessive borrowing. Since housing bubbles can support a constant loan‐to‐value (LTV) ratio lower than LTV limits, peripheral economies can lock into a steady‐state Ponzi growth equilibrium with high growth and current account deficits, but these economies become vulnerable to crises. We identify the “self‐fulfilling crisis region” (SFCR), in which the economy grows fast with a seemingly safe LTV ratio, but with a vulnerability to crises. Moreover, a crisis in one sector propagates to other sectors by endogenously expanding their SFCRs. We derive some policy implications on LTV regulations and market psychology. Finally, our calibration exercise presents how bubbles develop and burst along with contagion across sectors, accounting for the data. (JEL E44, F34, O16)
ISSN:0095-2583
1465-7295
DOI:10.1111/ecin.12745