Working Paper

Distributional Incentives in an Equilibrium Model of Domestic Sovereign Default

Abstract: Europe?s debt crisis resembles historical episodes of outright default on domestic public debt about which little research exists. This paper proposes a theory of domestic sovereign default based on distributional incentives affecting the welfare of risk-averse debt and non-debtholders. A utilitarian government cannot sustain debt if default is costless. If default is costly, debt with default risk is sustainable, and debt falls as the concentration of debt ownership rises. A government favoring bondholders can also sustain debt, with debt rising as ownership becomes more concentrated. These results are robust to adding foreign investors, redistributive taxes, or a second asset.

Keywords: Public debt; Sovereign default; European debt crisis;

JEL Classification: E44; E6; F34; H63;

Bibliographic Information

Provider: Federal Reserve Bank of Philadelphia

Part of Series: Working Papers

Publication Date: 2016-08-09

Number: 16-23

Pages: 72 pages