Deadly Embrace - Sovereign and Financial Balance Sheets Doom Loops

Emmanuel Farhi and Jean Tirole

The recent unravelling of the Eurozone’s financial integration raised concerns about feedback loops between sovereign and banking insolvency. The paper provides a theory of the feed backloop that allows for both domestic bailouts of the banking system and sovereign debt forgiveness by international creditors or solidarity by other countries. The theory has important implications for the re-nationalization of sovereign debt, macroprudential regulation, and the rationale for banking unions.


Farhi, Emmanuel and Tirole, Jean, "Deadly Embrace: Sovereign and Financial Balance Sheets Doom Loops", EconPol Working Paper 1, August 2017.