History Remembered: Optimal Sovereign Default on Domestic and External Debt
88 Pages Posted: 23 Oct 2019 Last revised: 24 Oct 2019
There are 3 versions of this paper
History Remembered: Optimal Sovereign Default on Domestic and External Debt
History Remembered: Optimal Sovereign Default on Domestic and External Debt
History Remembered: Optimal Sovereign Default on Domestic and External Debt
Date Written: July, 2019
Abstract
Infrequent but turbulent overt sovereign defaults on domestic creditors are a ?for- gotten history? in macroeconomics. We propose a heterogeneous-agents model in which the government chooses optimal debt and default on domestic and foreign creditors by balancing distributional incentives versus the social value of debt for self-insurance, liquidity, and risk-sharing. A rich feedback mechanism links debt issuance, the distribution of debt holdings, the default decision, and risk premia. Calibrated to Eurozone data, the model is consistent with key long-run and debt-crisis statistics. Defaults are rare (1.2 percent frequency) and preceded by surging debt and spreads. Debt sells at the risk-free price most of the time, but the government?s lack of commitment reduces sustainable debt sharply.
Keywords: public debt, sovereign defaults, debt crisis, European crisis
JEL Classification: E44, E6, F34, H63
Suggested Citation: Suggested Citation