Equilibrium Sovereign Default with Exchange Rate Depreciation

Sergey Popov and David Wiczer

No 2014-49, Working Papers from Federal Reserve Bank of St. Louis

Abstract: This study proposes and quantitatively assesses a terms-of-trade penalty for defaulting: defaulters must exchange more of their own goods for imports, which causes an adjustment to the equilibrium exchange rate. This penalty can take the place of an ad hoc fall in output: Facing only this penalty and temporary exclusion from debt markets, countries are willing to maintain borrowing obligations up to a realistic level of debt. The terms-of-trade penalty is consistent with the observed relationship between sovereign default and a country's trade flows and prices. The defaulter's currency depreciates while trade volume falls drastically. We demonstrate that a default episode can imply up to a 30% real depreciation, which matches observed crisis events in developing countries.

Keywords: endogenous default; exchange rates; trade balance (search for similar items in EconPapers)
JEL-codes: F11 F17 F34 (search for similar items in EconPapers)
Pages: 36 pages
Date: 2014-11-24
New Economics Papers: this item is included in nep-dge and nep-opm
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Related works:
Working Paper: Equilibrium sovereign default with endogenous exchange rate depreciation (2009)
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DOI: 10.20955/wp.2014.049

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