Creator: Benjamin, David and Wright, Mark L. J. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 753 Abstract:
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 often occurs; this delay can sometimes be socially efficient. Second, prohibiting debt issuance as part of a settlement makes delay less likely to occur in equilibrium. Third, when debt issuance is not fully state contingent, delay can arise because of the risk that the sovereign will default on any debt issued as part of the settlement.
Keyword: Bargaining, Sovereign debt, Sovereign default, and Delay Subject (JEL): H63 - National Debt; Debt Management; Sovereign Debt, F34 - International Lending and Debt Problems, and C78 - Bargaining Theory; Matching Theory
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
Creator: Schlegl, Matthias, Trebesch, Christoph, and Wright, Mark L. J. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 759 Abstract:
Sovereign governments owe debt to many foreign creditors and can choose which creditors to favor when making payments. This paper documents the de facto seniority structure of sovereign debt using new data on defaults (missed payments or arrears) and creditor losses in debt restructuring (haircuts). We overturn conventional wisdom by showing that official bilateral (government-to-government) debt is junior, or at least not senior, to private sovereign debt such as bank loans and bonds. Private creditors are typically paid first and lose less than bilateral official creditors. We confirm that multilateral institutions like the IMF and World Bank are senior creditors.
Keyword: Sovereign default, IMF, International financial architecture, Pecking order, Insolvency, Official debt, Sovereign bonds, Arrears, and Priority Subject (JEL): G10 - General Financial Markets: General (includes Measurement and Data), F30 - International Finance: General, F50 - International Relations, National Security, and International Political Economy: General, and F40 - Macroeconomic Aspects of International Trade and Finance: General
Creator: Boyd, John H. and Gertler, Mark Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 531 Abstract:
This paper reexamines the conventional wisdom that commercial banking is an industry in severe decline. We find that a careful reading of the evidence does not justify this conclusion. It is true that on-balance sheet assets held by commercial banks have declined as a share of total intermediary assets. But this measure overstates any drop in banking, for three reasons. First, it ignores the rapid growth in commercial banks' off-balance sheet activities. Second, it fails to take account of the substantial growth in off-shore C&I lending by foreign banks. Third, it ignores the fact that over the last several decades financial intermediation has grown rapidly relative to the rest of the economy. We find that after adjusting the measure of bank assets to account for these considerations there is no clear evidence of secular decline. To corroborate these findings, we also construct an alternative measure of the importance of banking, using data from the National Income Accounts. Again, we find no clear evidence of a sustained declined. At most the industry may have suffered a slight loss of market share over the last decade. But as we discuss, this loss may reflect a transitory response to a series of adverse shocks and the phasing in of new regulatory requirements, rather than the beginning of a permanent decline.
Keyword: Lending, Bank assets, Banking, Intermediation, and Commercial banks Subject (JEL): G21 - Banks; Depository Institutions; Micro Finance Institutions; Mortgages
Creator: Bocola, Luigi Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 722 Abstract:
This paper examines the macroeconomic implications of sovereign credit risk in a business cycle model where banks are exposed to domestic government debt. The news of a future sovereign default hampers financial intermediation. First, it tightens the funding constraints of banks, reducing their available resources to finance firms (liquidity channel). Second, it generates a precautionary motive for banks to deleverage (risk channel). I estimate the model using Italian data, finding that i) sovereign credit risk was recessionary and that ii) the risk channel was sizable. I then use the model to evaluate the effects of subsidized long term loans to banks, calibrated to the ECB’s longer-term refinancing operations. The presence of strong precautionary motives at the time of policy enactment implies that bank lending to firms is not very sensitive to these credit market interventions.
Keyword: Credit policies, Financial constraints, and Sovereign debt crises Subject (JEL): E44 - Financial Markets and the Macroeconomy, G21 - Banks; Depository Institutions; Micro Finance Institutions; Mortgages, E32 - Business Fluctuations; Cycles, and G01 - Financial Crises
Creator: Kehoe, Timothy Jerome, 1953- and Meza, Felipe Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 693 Abstract:
In 1950 Mexico entered an economic takeoff and grew rapidly for more than 30 years. Growth stopped during the crises of 1982–1995, despite major reforms, including liberalization of foreign trade and investment. Since then growth has been modest. We analyze the economic history of Mexico 1877–2010. We conclude that the growth 1950–1981 was driven by urbanization, industrialization, and education and that Mexico would have grown even more rapidly if trade and investment had been liberalized sooner. If Mexico is to resume rapid growth — so that it can approach U.S. levels of income — it needs further reforms.
Keyword: Total factor productivity, Mexico, and Economic growth Subject (JEL): O54 - Economywide Country Studies: Latin America; Caribbean, N16 - Economic History: Macroeconomics and Monetary Economics; Industrial Structure; Growth; Fluctuations: Latin America; Caribbean, and O11 - Macroeconomic Analyses of Economic Development
Creator: Boyd, John H., Chang, Chun, and Smith, Bruce D. (Bruce David), 1954-2002 Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 585 Abstract:
Many claims have been made about the potential benefits and the potential costs of adopting a system of universal banking in the United States. We evaluate these claims using a model where there is a moral hazard problem between banks and "borrowers," a moral hazard problem between banks and a deposit insurer, and a costly state verification problem. Under conditions we describe, allowing banks to take equity positions in firms strengthens their ability to extract surplus, and exacerbates problems of moral hazard. The incentives of universal banks to take equity positions will often be strongest when these problems are most severe.
Creator: Chodorow-Reich, Gabriel, Karabarbounis, Loukas, and Kekre, Rohan Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 758 Abstract:
The Greek economy experienced a boom until 2007, followed by a prolonged depression resulting in a 25 percent shortfall of GDP by 2016. Informed by a detailed analysis of macroeconomic patterns in Greece, we estimate a rich dynamic general equilibrium model to assess quantitatively the sources of the boom and bust. Lower external demand for traded goods and contractionary fiscal policies account for the largest fraction of the Greek depression. A decline in total factor productivity, due primarily to lower factor utilization, substantially amplifies the depression. Given the significant adjustment of prices and wages observed throughout the cycle, a nominal devaluation would only have short-lived stabilizing effects. By contrast, shifting the burden of adjustment away from taxes toward spending or away from capital taxes toward other taxes would generate longer-term production and consumption gains. Eliminating the rise in transfers to households during the boom would significantly reduce the burden of tax adjustment in the bust and the magnitude of the depression.
Keyword: Greek depression, Taxes, Fiscal policy, Nominal rigidity, and Productivity Subject (JEL): E44 - Financial Markets and the Macroeconomy, E62 - Fiscal Policy, F41 - Open Economy Macroeconomics, E32 - Business Fluctuations; Cycles, and E20 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy: General (includes Measurement and Data)
Creator: Bianchi, Javier, Ottonello, Pablo, and Presno, Ignacio Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 762 Abstract:
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 default, but a well-designed "fiscal forward guidance" can help reduce the excess procyclicality.
Keyword: Procyclicality, Fiscal stabilization policy, and Sovereign default Subject (JEL): F44 - International Business Cycles, H50 - National Government Expenditures and Related Policies: General, E62 - Fiscal Policy, F41 - Open Economy Macroeconomics, and F34 - International Lending and Debt Problems