History Remembered: Optimal Sovereign Default on Domestic and External Debt
Pablo D'Erasmo () and
Enrique Mendoza ()
No 25073, NBER Working Papers from National Bureau of Economic Research, Inc
Infrequent but turbulent overt sovereign defaults on domestic creditors are a “forgotten history” in Macroeconomics. We propose a heterogeneous-agents model in which the government chooses optimal debt and default on domestic and foreign creditors by balancing distributional incentives v. the social value of debt for self-insurance, liquidity, and risk-sharing. A rich feedback mechanism links debt issuance, the distribution of debt holdings, the default decision, and risk premia. Calibrated to Eurozone data, the model is consistent with key long-run and debt-crisis statistics. Defaults are rare (1.2 percent frequency), and preceded by surging debt and spreads. Debt sells at the risk-free price most of the time, but the government's lack of commitment reduces sustainable debt sharply.
JEL-codes: E44 E6 F34 H63 (search for similar items in EconPapers)
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Published as Pablo D’Erasmo & Enrique G. Mendoza, 2020. "History Remembered: Optimal Sovereign Default on Domestic and External Debt," Journal of Monetary Economics, .
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Working Paper: History Remembered: Optimal Sovereign Default on Domestic and External Debt (2019)
Working Paper: History Remembered: Optimal Sovereign Default on Domestic and External Debt (2018)
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