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Working Paper
Sovereign Default: The Role of Expectations
We study a variation of the standard model of sovereign default, as in Aguiar and Gopinath (2006) or Arellano (2008), and show that this variation is consistent with multiple interest rate equilibria. Some of those equilibria correspond to the ones identified by Calvo (1988), where default is likely because rates are high, and rates are high because default is likely. The model is used to simulate equilibrium movements in sovereign bond spreads that resemble sovereign debt crises. It is also used to discuss lending policies similar to the ones announced by the European Central Bank in 2012.
Working Paper
Climate Defaults and Financial Adaptation
We analyze the relationship between climate-related disasters and sovereign debt crises using a model with capital accumulation, sovereign default, and disaster risk. We find that disaster risk and default risk together lead to slow post-disaster recovery and heightened borrowing costs. Calibrating the model to Mexico, we find that the increase in cyclone risk due to climate change leads to a welfare loss equivalent to a permanent 1% consumption drop. However, financial adaptation via catastrophe bonds and disaster insurance can reduce these losses by about 25%. Our study highlights the ...
Report
Renegotiation Policies in Sovereign Defaults
This paper studies an optimal renegotiation protocol designed by a benevolent planner when two countries renegotiate with the same lender. The solution calls for recoveries that induce each country to default or repay, trading off the deadweight costs and the redistribution benefits of default independently of the other country. This outcome contrasts with a decentralized bargaining solution where default in one country increases the likelihood of default in the second country because recoveries are lower when both countries renegotiate. The paper suggests that policies geared at designing ...
Working Paper
Fiscal Stimulus Under Sovereign Risk
The excess procyclicality of fiscal policy is commonly viewed as a central malaise in emerging economies. We document that procyclicality is more pervasive in countries with higher sovereign risk and provide a model of optimal fiscal policy with nominal rigidities and endogenous sovereign default that can account for this empirical pattern. Financing a fiscal stimulus is costly for risky countries and can render countercyclical policies undesirable, even in the presence of large Keynesian stabilization gains. We also show that imposing austerity can backfire by exacerbating the exposure to ...
Working Paper
Sovereign Risk and Fiscal Information: A Look at the U.S. State Default of the 1840s
This paper examines how newspaper reporting affects government bond prices during the U.S. state default of the 1840s. Using unsupervised machine learning algorithms, the paper first constructs novel ``fiscal information indices'' for state governments based on U.S. newspapers at the time. The impact of the indices on government bond prices varied over time. Before the crisis, the entry of new western states into the bond market spurred competition: more state-specific fiscal news imposed downward pressure on bond prices for established states in the market. During the crisis, more ...
Report
Real Interest Rates, Inflation, and Default
This paper argues that the comovement between inflation and economic activity is an important determinant of real interest rates over time and across countries. First, we show that for advanced economies, periods with more procyclical inflation are associated with lower real rates, but only when there is no risk of default on government debt. Second, we present a model of nominal sovereign debt with domestic risk-averse lenders. With procyclical inflation, nominal bonds pay out more in bad times, making them a good hedge against aggregate risk. In the absence of default risk, procyclical ...
Report
Monetary Policy and Sovereign Risk in Emerging Economies (NK-Default)
This paper develops a New Keynesian model with sovereign default risk (NK-Default). We focus on the interaction between monetary policy, conducted according to an interest rate rule that targets inflation, and external defaultable debt issued by the government. Monetary policy and default risk interact since both affect domestic consumption, production, and inflation. We find that default risk amplifies monetary frictions and generates a tension for monetary policy, which increases the volatility of inflation and nominal rates. These monetary frictions in turn discipline sovereign borrowing, ...
Working Paper
Self-Fulfilling Debt Crises with Long Stagnations
We explore quantitatively the possibility of multiple equilibria in a model of sovereign debt crises. The source of multiplicity is the one identified by Calvo (1988). This type of multiplicity has been at the heart of the policy debate through the recent European sovereign debt crisis. Key for multiplicity in the model is a stochastic process for output featuring long periods of either high or low growth. We calibrate the output process in the model using data for the southern European countries that were exposed to the debt crisis. We find that expectations-driven sovereign debt crises are ...
Working Paper
Efficient Computation with Taste Shocks
Taste shocks result in nondegenerate choice probabilities, smooth policy functions, continuous demand correspondences, and reduced computational errors. They also cause significant computational cost when the number of choices is large. However, I show that, in many economic models, a numerically equivalent approximation may be obtained extremely efficiently. If the objective function has increasing differences (a condition closely tied to policy function monotonicity) or is concave in a discrete sense, the proposed algorithms are O(n log n) for n states and n choice--a drastic improvement ...
Working Paper
Deconstructing Delays in Sovereign Debt Restructuring
Negotiations to restructure sovereign debt are time consuming, taking almost a decade on average to resolve. In this paper, we analyze a class of widely used complete information models of delays in sovereign debt restructuring and show that, despite superficial similarities, there are major differences across models in the driving force for equilibrium delay, the circumstances in which delay occurs, and the efficiency of the debt restructuring process. We focus on three key assumptions. First, if delay has a permanent effect on economic activity in the defaulting country, equilibrium delay ...