The Optimal Size of the European Stability Mechanism: A Cost-Benefit Analysis

34 Pages Posted: 22 Aug 2012

See all articles by Daniel Kapp

Daniel Kapp

European Central Bank (ECB)

Date Written: August 21, 2012

Abstract

This study presents a core-periphery model to determine the optimal size of the European Stability Mechanism (ESM), building on Jeanne and Ranciere (2011). While the periphery is subject to a probability of losing access to external credit, the core's incentive for setting up an ESM stems exclusively from the spillover effects present in the case of periphery default. The model develops regional best response functions, determining a set of feasible ranges for the total ESM size, given optimal regional contributions. The model is then calibrated to the European Economic and Monetary Union. If costs from default are reasonably high, the probability of the periphery not having access to external credit is sufficiently large, and spillover effects to the core are present, both the core and the periphery have an interest in contributing to the ESM. Calibration and sensitivity analysis suggest that the optimal ESM size is between the current and twice the size of the agreed-upon ESM.

Keywords: ESM, ESFR, Financial Crisis, Insurance

JEL Classification: G01, G17, G22, G32, C15

Suggested Citation

Kapp, Daniel, The Optimal Size of the European Stability Mechanism: A Cost-Benefit Analysis (August 21, 2012). De Nederlandsche Bank Working Paper No. 349, Available at SSRN: https://ssrn.com/abstract=2133240 or http://dx.doi.org/10.2139/ssrn.2133240

Daniel Kapp (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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