Sovereign debt markets in turbulent times: creditor discrimination and crowding-out effects

Fernando Broner, Alberto Martin, Jaume Ventura and Aitor Erce
Additional contact information
Jaume Ventura: CREI, Universitat Pompeu Fabra and Barcelona GSE

No 1402, Working Papers from Banco de España

Abstract: In 2007, countries in the euro periphery were enjoying stable growth, low deficits and low spreads. Then the financial crisis erupted and pushed them into deep recession, raising their deficits and debt levels. By 2010, they were facing severe debt problems. Spreads increased and, surprisingly, so did the share of the debt held by domestic creditors. Credit was reallocated from the private to the public sector, reducing investment and deepening the recession even further. To account for these facts, we propose a simple model of sovereign risk in which debt can be traded in secondary markets. The model has two key ingredients: creditor discrimination and crowding-out effects. Creditor discrimination arises because, in turbulent times, sovereign debt offers a higher expected return to domestic creditors than to foreign ones. This provides incentives for domestic purchases of debt. Crowding-out effects arise because private borrowing is limited by financial frictions. This implies that domestic debt purchases displace productive investment. The model shows that these purchases reduce growth and welfare, and may lead to self-fulfilling crises. It also shows how crowding-out effects can be transmitted to other countries in the euro zone, and how they may be addressed by policies at the European level.

Keywords: sovereign debt; discrimination; crowding out; rollover crises; economic growth (search for similar items in EconPapers)
JEL-codes: F32 F34 F36 F41 F43 F44 F65 G15 (search for similar items in EconPapers)
Pages: 69 pages
Date: 2014-02
New Economics Papers: this item is included in nep-eec, nep-fdg and nep-opm
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Citations: View citations in EconPapers (256)

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http://www.bde.es/f/webbde/SES/Secciones/Publicaci ... /14/Fich/dt1402e.pdf First version, February 2014 (application/pdf)

Related works:
Working Paper: Sovereign Debt Markets in Turbulent Times: Creditor Discrimination and Crowding-Out Effects (2015)
Journal Article: Sovereign debt markets in turbulent times: Creditor discrimination and crowding-out effects (2014)
Working Paper: Sovereign Debt Markets in Turbulent Times: Creditor Discrimination and Crowding-Out Effects (2013)
Working Paper: Sovereign Debt Markets in Turbulent Times: Creditor Discrimination and Crowding-Out Effects (2013)
Working Paper: Sovereign debt markets in turbulent times: Creditor discrimination and crowding-out effects (2013)
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