The Eurozone game: conflicting policy preferences in an integrated capital market

In an OLG framework, capital market integration leads to interest rate equalisation as the sovereign liabilities of highly-indebted countries are transferred to partner countries with high savings and low interest rates. Indeed we find that, in equilibrium, the bulk of the existing debt of highly-indebted sovereigns will be transferred to others in this fashion. When account is taken of incentives to create more debt, however, what can emerge is a “discoordination game” with a mixed-strategy equilibrium including a crisis. Balanced-budget rules ∗We are grateful to financial support from the ESRC Research Centre of Competitive Advantage in the Global Economy. †University of Warwick. ‡University of York. §University of Warwick.