International Lending, Sovereign Debt and Joint Liability

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.

This paper is a product of the Office of the Chief Economist, Development Economics Vice Presidency. It is part of a larger
effort by the World Bank to provide open access to its research and make a contribution to development policy discussions
around the world. Policy Research Working Papers are also posted on the Web at http://econ.worldbank.org. The authors
may be contacted at [email protected] and [email protected].