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Sovereign debt markets in turbulent times: creditor discrimination and crowding-out effects

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Author Info

  • Fernando Broner

    (CREI, Universitat Pompeu Fabra and Barcelona GSE)

  • Alberto Martin

    (CREI, Universitat Pompeu Fabra and Barcelona GSE)

  • Jaume Ventura

    (CREI, Universitat Pompeu Fabra and Barcelona GSE)

  • Aitor Erce

    (Banco de España and European stability mechanism)

Abstract

In 2007, countries in the euro periphery were enjoying stable growth, low deficits and low spreads. Then the financial crisis erupted and pushed them into deep recession, raising their deficits and debt levels. By 2010, they were facing severe debt problems. Spreads increased and, surprisingly, so did the share of the debt held by domestic creditors. Credit was reallocated from the private to the public sector, reducing investment and deepening the recession even further. To account for these facts, we propose a simple model of sovereign risk in which debt can be traded in secondary markets. The model has two key ingredients: creditor discrimination and crowding-out effects. Creditor discrimination arises because, in turbulent times, sovereign debt offers a higher expected return to domestic creditors than to foreign ones. This provides incentives for domestic purchases of debt. Crowding-out effects arise because private borrowing is limited by financial frictions. This implies that domestic debt purchases displace productive investment. The model shows that these purchases reduce growth and welfare, and may lead to self-fulfilling crises. It also shows how crowding-out effects can be transmitted to other countries in the euro zone, and how they may be addressed by policies at the European level.

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Bibliographic Info

Paper provided by Banco de Espa�a in its series Banco de Espa�a Working Papers with number 1402.

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Length: 69 pages
Date of creation: Feb 2014
Date of revision:
Handle: RePEc:bde:wpaper:1402

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Keywords: sovereign debt; discrimination; crowding out; rollover crises; economic growth;

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References

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  1. Alexander Guembel & Oren Sussman, 2009. "Sovereign Debt without Default Penalties," Review of Economic Studies, Oxford University Press, vol. 76(4), pages 1297-1320.
  2. Broner, Fernando & Didier, Tatiana & Erce, Aitor & Schmukler, Sergio L., 2011. "Gross capital flows : dynamics and crises," Policy Research Working Paper Series 5768, The World Bank.
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Citations

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Cited by:
  1. Serkan Arslanalp & Takahiro Tsuda, 2014. "Tracking Global Demand for Emerging Market Sovereign Debt," IMF Working Papers 14/39, International Monetary Fund.
  2. Harald Uhlig, 2013. "Sovereign Default Risk and Banks in a Monetary Union," CESifo Working Paper Series 4368, CESifo Group Munich.
  3. Michele Fratianni & Francesco Marchionne, 2014. "Bank asset reallocation and sovereign debt," Working Papers, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy 2014-09, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy.
  4. Camille Cornand & Pauline Gandré & Céline Gimet, 2014. "Increase in Home Bias and the Eurozone Sovereign Debt Crisis," Working Papers, HAL halshs-01015475, HAL.
  5. Balteanu, Irina & Erce, Aitor, 2014. "Bank Crises and Sovereign Defaults in Emerging Markets: Exploring the Links," Globalization and Monetary Policy Institute Working Paper, Federal Reserve Bank of Dallas 184, Federal Reserve Bank of Dallas.
  6. Galina Hale & Maurice Obstfeld, 2014. "The Euro and The Geography of International Debt Flows," NBER Working Papers 20033, National Bureau of Economic Research, Inc.
  7. Erce, Aitor, 2014. "Banking on seniority: the IMF and the sovereign’s creditors," Globalization and Monetary Policy Institute Working Paper, Federal Reserve Bank of Dallas 175, Federal Reserve Bank of Dallas.
  8. Paolo Angelini & Giuseppe Grande & Fabio Panetta, 2014. "The negative feedback loop between banks and sovereigns," Questioni di Economia e Finanza (Occasional Papers), Bank of Italy, Economic Research and International Relations Area 213, Bank of Italy, Economic Research and International Relations Area.
  9. Filippo Brutti & Philip Ulrich Sauré, 2014. "Repatriation of Debt in the Euro Crisis: Evidence for the Secondary Market Theory," Working Papers 2014-03, Swiss National Bank.
  10. Camille Cornand & Pauline Gandré & Céline Gimet, 2014. "Increase in Home Bias and the Eurozone Sovereign Debt Crisis," Working Papers, Groupe d'Analyse et de Théorie Economique (GATE), Centre national de la recherche scientifique (CNRS), Université Lyon 2, Ecole Normale Supérieure 1419, Groupe d'Analyse et de Théorie Economique (GATE), Centre national de la recherche scientifique (CNRS), Université Lyon 2, Ecole Normale Supérieure.

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