Template-Type: ReDIF-Paper 1.0
Series: Tinbergen Institute Discussion Papers
Creation-Date: 2021-01-21
Number: 21-009/IV
Author-Name: Xuan Wang
Author-Workplace-Name: Vrije Universiteit Amsterdam
Title: Bankruptcy Codes and Risk Sharing of Currency Unions
Abstract: Since the Eurozone Crisis of 2010-12, a critical debate on the viability of a currency union has focused on the role of a fiscal union in adjusting for country heterogeneity. However, a fully-fledged fiscal union may not be politically feasible. This paper develops a two-country general equilibrium model to examine the benefits of the bankruptcy code of a capital markets union - in the absence of a fiscal union - as an alternative mechanism to improve the financial stability and welfare of a currency union. When domestic credit risks are present, I show that a lenient bankruptcy code in the cross-border capital markets union removes the pecuniary externality of banking insolvency, so it leads to a Pareto improvement within the currency union. Moreover, the absence of floating nominal exchange rates removes a mechanism to neutralise domestic credit risks; I show that softening the bankruptcy code can recoup the lost benefits of floating nominal exchange rates. The model provides the financial stability and welfare implications of bankruptcy within a capital markets union in the Eurozone.
Classification-JEL: E42, F33, G15, G21
Keywords: Equilibrium default, bankruptcy code, fiscal union, capital markets union, financial stability, bank credit and inside money, price-level and exchange rate determinacy, liquidity-intermediary asset pricing
File-URL: https://papers.tinbergen.nl/21009.pdf
File-Format: application/pdf
File-Size: 1573522 bytes
Handle: RePEc:tin:wpaper:20210009