Bailout Dynamics in a Monetary Union

This paper analyzes country bailouts in a monetary union within a framework where sovereign default and exit from the union are two separate decisions. The studied bailouts are meant to prevent an exit and, thus, do not exclude subsequent defaults. The model replicates the experience of Greece, which received multiple rounds of implicit fiscal transfers exceeding altogether 40% of its GDP. Despite the fiscal assistance, Greece defaulted on its debt and went through a deep and prolonged recession. The model captures the coexistence of bailouts, default, and recession. It also sheds new light on the moral hazard discussion related to bailouts by showing no significant effects from exit-driven bailouts