Working Paper: Deadly Embrace - Sovereign and Financial Balance Sheets Doom Loops

Jean Tirole, Nobel Memorial Prize Winner in Economic Sciences, TSE, and Harvard top economist Emmanuel Farhi provide here their theory of the feedback loop that allows for both domestic bailouts of the banking system and sovereign debt forgiveness by international creditors or solidarity by other countries. The theory, referring to the recent unravelling of the Eurozone’s financial integration that raised concerns about feedback loops between sovereign and banking insolvency, has important implications for the re-nationalization of sovereign debt, macroprudential regulation, and the rationale for banking unions.