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The Pass-Through of Sovereign Risk

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  • Luigi Bocola

Abstract

This paper examines the macroeconomic implications of sovereign risk in a model in which banks hold domestic government debt. News of a future sovereign default hampers financial intermediation. First, it tightens the funding constraints of banks, reducing their resources to finance firms (liquidity channel). Second, it generates a precautionary motive to deleverage (risk channel). I estimate the model using Italian data, finding that sovereign risk was recessionary and that the risk channel was sizable. I also use the model to measure the effects of subsidized long-term loans to banks. Precautionary motives at the height of the crisis imply that bank lending to firms responds little to these interventions.

Suggested Citation

  • Luigi Bocola, 2016. "The Pass-Through of Sovereign Risk," Journal of Political Economy, University of Chicago Press, vol. 124(4), pages 879-926.
    • Handle: RePEc:ucp:jpolec:doi:10.1086/686734
    DOI: 10.1086/686734
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    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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