International Spillovers and Bailouts

Marina Azzimonti, Stony Brook University and Vincenzo Quadrini, University of Southern California

We study how cross-country macroeconomic spillovers caused by sovereign default affect equilibrium bailouts. Because of portfolio diversification, the default of one country causes a macroeconomic contraction in other countries, which motivates a bailout. But why do creditor countries choose to bail out debtor countries instead of their own private sector? We show that this is because an external bailout could be cheaper than a domestic bailout. We also show that, although anticipated bailouts lead to higher borrowing, they can be Pareto improving not only ex-post (after a country has defaulted) but also ex-ante (before the country chooses its debt).