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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.
Palabra clave: Interference with private contracts, Tax flexibility, Sudden stops, and Debt crises Tema: H70 - State and Local Government; Intergovernmental Relations: General, F30 - International Finance: General, and K10 - Basic Areas of Law: General (Constitutional Law)
Creator: Arellano, Cristina and Bai, Yan Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 491 Abstract:
We develop a multicountry model in which default in one country triggers default in other countries. Countries are linked to one another by borrowing from and renegotiating with common lenders. Countries default together because by doing so they can renegotiate the debt simultaneously and pay lower recoveries. Defaulting is also attractive in response to foreign defaults because the cost of rolling over the debt is higher when other countries default. Such forces are quantitatively important for generating a positive correlation of spreads and joint incidence of default. The model can rationalize some of the recent economic events in Europe as well as the historical patterns of defaults, renegotiations, and recoveries across countries.
Palabra clave: Self-fulfilling crisis, Sovereign default, European debt crisis, Contagion, and Renegotiation Tema: G01 - Financial Crises and F30 - International Finance: General
Creator: Aiyagari, S. Rao and McGrattan, Ellen R. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 203 Abstract:
We find that the welfare gains to being at the optimum quantity of debt rather than the current U.S. level are small, and, therefore, concerns regarding the high level of debt in the U.S. economy may be misplaced. This finding is based on a model of a large number of infinitely-lived households whose saving behavior is influenced by precautionary saving motives and borrowing constraints. This model incorporates a different role for government debt than is found in standard models, and it captures different cost-benefit trade-offs. On the benefit side, government debt enhances the liquidity of households by providing an additional means of smoothing consumption and by effectively loosening borrowing constraints. On the cost side, the implied taxes have adverse wealth distribution and incentive effects. In addition, government debt crowds out capital via higher interest rates and lowers per capita consumption.
Creator: Bryant, John B. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 121 Palabra clave: Interest, Nontransferable bonds, and Money Tema: H62 - National Deficit; Surplus and G12 - Asset Pricing; Trading Volume; Bond Interest Rates
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.
Palabra clave: Sovereign debt, Delay, Sovereign default, and Bargaining Tema: F34 - International Lending and Debt Problems, H63 - National Debt; Debt Management; Sovereign Debt, and C78 - Bargaining Theory; Matching Theory
Creator: Ayres, João, Navarro, Gaston, Nicolini, Juan Pablo, and Teles, Pedro Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 757 Abstract:
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 empirically plausible, but only in periods of stagnation. Multiplicity is state dependent: in periods of stagnation and for intermediate levels of debt, interest rates may be high for reasons unrelated to fundamentals.
Palabra clave: Multiplicity, Stagnation, Sovereign default, Self-fulfilling debt crises, and Good and bad times Tema: F34 - International Lending and Debt Problems and E44 - Financial Markets and the Macroeconomy
Creator: Aguiar, Mark and Amador, Manuel Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 518 Abstract:
We study optimal fiscal policy in a small open economy (SOE) with sovereign and private default risk and limited commitment to tax plans. The SOE's government uses linear taxation to fund exogenous expenditures and uses public debt to inter-temporally allocate tax distortions. We characterize a class of environments in which the tax on labor goes to zero in the long run, while the tax on capital income may be non-zero, reversing the standard prediction of the Ramsey tax literature. The zero labor tax is an optimal long run outcome if the economy is subject to sovereign debt constraints and the domestic households are impatient relative to the international interest rate. The front loading of tax distortions allows the economy to build a large (aggregate) debt position in the presence of limited commitment. We show that a similar result holds in a closed economy with imperfect inter-generational altruism, providing a link with the closed-economy literature that has explored disagreement between the government and its citizens regarding inter-temporal tradeoffs.
Palabra clave: Limited commitment, Fiscal policy, and Sovereign debt Tema: F34 - International Lending and Debt Problems, F38 - International Financial Policy: Financial Transactions Tax; Capital Controls, E62 - Fiscal Policy, and F32 - Current Account Adjustment; Short-term Capital Movements
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.
Palabra clave: Sovereign default, IMF, International financial architecture, Pecking order, Insolvency, Official debt, Sovereign bonds, Arrears, and Priority Tema: 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: Cole, Harold Linh, 1957-, Dow, James, 1961-, and English, William B. (William Berkeley), 1960- Series: International perspectives on debt, growth, and business cycles Abstract:
We consider a model of international sovereign debt where repayment is enforced because defaulting nations lose their reputation and consequently, are excluded from international capital markets. Underlying the analysis of reputation is the hypothesis that borrowing countries have different, unobservable, attitudes towards the future. Some regimes are relatively myopic, while others are willing to make sacrifices to preserve their access to debt markets. Nations' preferences, while unobservable, are not fixed but evolve over time according to a Markov process. We make two main points. First we argue that in models of sovereign debt the length of the punishment interval that follows a default should be based on economic factors rather than being chosen arbitrarily. In our model, the length of the most natural punishment interval depends primarily on the preference parameters. Second, we point out that there is a more direct way for governments to regain their reputation. By offering to partially repay loans in default, a government can signal its reliability. This type of signaling can cause punishment interval equilibria to break down. We examine the historical record on lending resumption to argue that in almost all cases, some kind of partial repayment was made.
Tema: H63 - National budget, deficit, and debt - Debt ; Debt management and F34 - International finance - International lending and debt problems
Creator: McGrattan, Ellen R. and Prescott, Edward C. Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 313 Abstract:
Mehra and Prescott (1985) found the difference between average equity and debt returns puzzling because it was too large to be a premium for bearing nondiversifiable aggregate risk. Here, we re-examine this puzzle, taking into account some factors ignored by Mehra and Prescott—taxes, regulatory constraints, and diversification costs—and focusing on long-term rather than short-term savings instruments. Accounting for these factors, we find the difference between average equity and debt returns during peacetime in the last century is less than 1 percent, with the average real equity return somewhat under 5 percent, and the average real debt return almost 4 percent. As theory predicts, the real return on debt has been close to the 4 percent average after-tax real return on capital. Similarly, as theory predicts, the real return on equity is equal to the after-tax real return on capital plus a modest premium for bearing nondiversifiable aggregate risk.
Tema: G12 - Asset Pricing; Trading Volume; Bond Interest Rates