The Insurance Value of a Monetary Union: Sovereign Debt and Reserve Pooling

Pooling foreign-exchange reserves can insure members of a currency union against the monetary consequences of national sovereign-debt distress, even when it does not prevent default. Monthly IMF central-bank accounts for the eight WAEMU members (2007–2026) show low comovement of national foreign claims and a regional coverage ratio about half as volatile as national ones. In a quantitative model of a member economy with long-duration defaultable debt under a fixed parity, pooled backing lowers the mean quarterly devaluation probability from 1.60 to 0.29 percent and sharply weakens the pass-through of national reserve losses to common coverage and the policy rate, while raising equilibrium borrowing (external debt of 53.5 versus 45.7 percent of GDP) and default frequency: insurance against devaluation is not insurance against default.