A Model of the Twin Ds: Optimal Default and Devaluation

Martín Uribe (), Schmitt-Grohé, Stephanie, Vivian Yue and Seunghoon Na
Authors registered in the RePEc Author Service: Stephanie Schmitt-Grohe

No 10697, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: This paper characterizes jointly optimal default and exchange-rate policy in a small open economy with limited enforcement of debt contracts and downward nominal wage rigidity. Under optimal policy, default occurs during contractions and is accompanied by large devaluations. The latter inflate away real wages thereby avoiding massive unemployment. Thus, the Twin Ds phenomenon emerges endogenously as the optimal outcome. By contrast, under fixed exchange rates, optimal default takes place in the context of large involuntary unemployment. Fixed-exchange-rate economies are shown to have stronger default incentives and therefore support less external debt than economies with optimally floating rates.

Keywords: Sovereign default; Exchange rates; Optimal monetary policy; Capital controls; Currency pegs; Downward nominal wage rigidity (search for similar items in EconPapers)
JEL-codes: E43 E52 F31 F34 F38 F41 (search for similar items in EconPapers)
Date: 2015-07
New Economics Papers: this item is included in nep-cba, nep-mac, nep-mon and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

Downloads: (external link)
https://cepr.org/publications/DP10697 (application/pdf)
CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org

Related works:
Working Paper: A model of the Twin Ds: optimal default and devaluation (2015)
Working Paper: A Model of the Twin Ds: Optimal Default and Devaluation (2015)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprdp:10697

Ordering information: This working paper can be ordered from
https://cepr.org/publications/DP10697

Access Statistics for this paper

More papers in CEPR Discussion Papers from C.E.P.R. Discussion Papers Centre for Economic Policy Research, 33 Great Sutton Street, London EC1V 0DX.
Bibliographic data for series maintained by ().