Creator: Arellano, Cristina, Atkeson, Andrew, and Wright, Mark L. J. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 515 Abstract:
The recent debt crises in Europe and the U.S. states feature similar sharp increases in spreads on government debt but also show important differences. In Europe, the crisis occurred at high government indebtedness levels and had spillovers to the private sector. In the United States, state government indebtedness was low, and the crisis had no spillovers to the private sector. We show theoretically and empirically that these different debt experiences result from the interplay between differences in the ability of governments to interfere in private external debt contracts and differences in the flexibility of state fiscal institutions.
Keyword: Interference with private contracts, Debt crises, Sudden stops, and Tax flexibility Subject (JEL): K10 - Basic Areas of Law: General (Constitutional Law), F30 - International Finance: General, and H70 - State and Local Government; Intergovernmental Relations: General
Creator: Arellano, Cristina, Mateos-Planas, Xavier, and Ríos-Rull, José-Víctor Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 589 Abstract:
In the data sovereign default is always partial and varies in its duration. Debt levels during default episodes initially increase and do not experience reductions upon resolution. This paper presents a theory of sovereign default that replicates these properties, which are absent in standard sovereign default theory. Partial default is a flexible way to raise funds as the sovereign chooses its intensity and duration. Partial default is also costly because it amplifies debt crises as the defaulted debt accumulates and interest rate spreads increase. This theory is capable of rationalizing the large heterogeneity in partial default, its comovements with spreads, debt levels, and output, and the dynamics of debt during default episodes. In our theory, as in the data, debt grows during default episodes, and large defaults are longer, and associated with higher interest rate spreads, higher debt levels, and deeper recessions.
Keyword: Sovereign risk, Emerging markets, Debt crises, and Debt restructuring Subject (JEL): F34 - International Lending and Debt Problems, H63 - National Debt; Debt Management; Sovereign Debt, and G01 - Financial Crises