Working Paper

Domestic Debt and Sovereign Defaults


Abstract: This paper examines how domestic holdings of government debt affect sovereign default risk and government debt management. I develop a dynamic stochastic general equilibrium model with both external and domestic debt that endogenously generates output contraction upon default. Domestic holdings of government debt weaken investors' balance sheets and induce a contraction of credit and output upon default. I calibrate the model to the Argentinean economy and show that the model reproduces key empirical moments. Introducing domestic debt also yields relevant normative implications. While domestic debt is crucial to determining the risk of default, the efficient internal-external composition of debt cannot be achieved without government intervention. Pigouvian subsidies can restore efficiency.

Keywords: Sovereign Defaults; Domestic Debt; Debt Crises; Credit Market;

JEL Classification: F34; F41; H63;

https://doi.org/10.17016/IFDP.2015.1153

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Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: International Finance Discussion Papers

Publication Date: 2015-12-18

Number: 1153

Pages: 42 pages