Business Cycles

This paper studies official sovereign debt empirically and theoretically. Official sovereign debt is more than half of the total sovereign debt in emerging markets and tends to flow in during default episodes. We develop a model with official and private debt where the sovereign can partially default on each of its debts. A fraction of the defaulted debt accumulates during a default episode, which resolves when the sovereign pays back its accrued obligations. Official debt is longer-term and more concessional during defaults than private debt, and the prices of all debts compensate lenders for default losses. The contractual differences across debts allow our model to rationalize the stylized facts of emerging markets. Counterfactual analysis suggests that official debt is welfare improving and finds the feasibility of voluntary swaps that generate Pareto Improvements by exchanging one type of debt for another one. Our work rationalizes the involvement of official debt in the resolution of sovereign defaults.

This paper explores the macroeconomic implications of tight global financial conditions in a small open economy New Keynesian model with sovereign default. My analysis shows that the interplay between the government incentives to repay the debt and inflation during periods of high world interest rates has distinct implications for monetary policy. I show that a monetary easing may emerge when a world interest rate hike induces a substantial increase in the probability of default, depressing domestic demand and leading firms to reduce inflation. This default amplification channel complements the expenditure-switching and expenditure-reducing channels found in standard open economy models, and rationalizes why emerging economies might reduce monetary policy rates when the Federal Reserve tightens. An increase in sovereign risk reduces aggregate domestic demand beyond these conventional channels, leading a real exchange rate depreciation to be contractionary for output.