An Economic Theory Model for Amending the Treaty of Lisbon

As the Eurozone crisis drags on, it is evident that a part of the problem lies in the architecture of debt and its liabilities within the Eurozone and, more generally, the European Union. This paper argues that a large part of the problem can be mitigated by permitting appropriately-structured cross-country liability for sovereign debt incurred by individual nations within the European Union. In brief, the paper makes a case for amending the Treaty of Lisbon. The case is established by constructing a game-theoretic model and demonstrating that there exist self-fulfilling equilibria, which would come into existence if cross-country debt liability were permitted and which are Pareto superior to the existing outcome. Acknowldgement: For many helpful comments and suggestions we are grateful to Karna Basu, Tito Cordella, Celestin Monga, Tamara McGavock, Luis Serven, Aristomene Varoudakis and, especially, Boyang Zhang. ∗Basu: The World Bank, 1818 H Street, N.W., Washington, D.C. 20433 and Department of Economics, Uris Hall, Cornell University, Ithaca, New York 14853 ([email protected]). Stiglitz: Department of Economics, Uris Hall, Columbia University, New York, New York 10027 ([email protected]).