A Model of the Twin Ds: Optimal Default and Devaluation

Vivian Yue, Stephanie Schmitt-Grohe, Martín Uribe () and Seunghoon Na
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Seunghoon Na: Columbia University

No 419, 2015 Meeting Papers from Society for Economic Dynamics

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.

Date: 2015
New Economics Papers: this item is included in nep-cba, nep-dge and nep-opm
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Citations: View citations in EconPapers (5)

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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)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed015:419

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