Default Risk, Sectoral Reallocation and Persistent Recessions

Cristina Arellano, Yan Bai and Gabriel Mihalache

No 555, Staff Report from Federal Reserve Bank of Minneapolis

Abstract: Sovereign debt crises are associated with large and persistent declines in economic activity, disproportionately so for nontradable sectors. This paper documents this pattern using Spanish data and builds a two-sector dynamic quantitative model of sovereign default with capital accumulation. Recessions are very persistent in the model and more pronounced for nontraded sectors because of default risk. An adverse domestic shock increases the likelihood of default, limits capital in?ows, and thus restricts the ability of the economy to exploit investment opportunities. The economy responds by reducing investment and reallocating capital toward the traded sector to support debt service payments. The real exchange rate depreciates, a re?ection of the scarcity of traded goods. We ?nd that these mechanisms are quantitatively important for rationalizing the experience of Spain during the recent debt crisis.

Keywords: Traded and nontraded production; Sovereign default with production economy; Capital accumulation; Real exchange rate; European debt crisis (search for similar items in EconPapers)
JEL-codes: E30 F30 (search for similar items in EconPapers)
Pages: 37 pages
Date: 2017-09-13
New Economics Papers: this item is included in nep-dge, nep-mac and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Related works:
Journal Article: Default risk, sectoral reallocation, and persistent recessions (2018)
Chapter: Default Risk, Sectoral Reallocation, and Persistent Recessions (2017)
Working Paper: Default Risk, Sectoral Reallocation, and Persistent Recessions (2017)
Working Paper: Default Risk, Sectoral Reallocation, and Persistent Recessions (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedmsr:555

DOI: 10.21034/sr.555

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