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Sovereign Debt Markets in Turbulent Times: Creditor Discrimination and Crowding-Out Effects

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  • Fernando Broner
  • Aitor Erce
  • Alberto Martín
  • Jaume Ventura

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 recessions, 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 sectors, reducing investment and deepening the recessions 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 Eurozone, and how they may be addressed by policies at the European level.

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Bibliographic Info

Paper provided by Barcelona Graduate School of Economics in its series Working Papers with number 701.

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Date of creation: Jun 2013
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Handle: RePEc:bge:wpaper:701

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Keywords: sovereign debt; rollover crises; secondary markets; economic growth;

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References

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  1. Broner, Fernando A & Martin, Alberto & Ventura, Jaume, 2007. "Sovereign Risk and Secondary Markets," CEPR Discussion Papers 6055, C.E.P.R. Discussion Papers.
  2. Yan Bai & Jing Zhang, 2009. "Duration of Sovereign Debt Renegotiation," Working Papers 593, Research Seminar in International Economics, University of Michigan.
  3. Mark Aguiar & Manuel Amador, 2009. "Growth in the Shadow of Expropriation," Discussion Papers 08-051, Stanford Institute for Economic Policy Research.
  4. Jaume Ventura & Fernando A. Broner, 2006. "Globalization and Risk Sharing," NBER Working Papers 12482, National Bureau of Economic Research, Inc.
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  24. Mark Aguiar & Manuel Amador & Emmanuel Farhi & Gita Gopinath, 2013. "Crisis and Commitment: Inflation Credibility and the Vulnerability to Sovereign Debt Crises," NBER Working Papers 19516, National Bureau of Economic Research, Inc.
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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. Paolo Angelini & Giuseppe Grande & Fabio Panetta, 2014. "The negative feedback loop between banks and sovereigns," Questioni di Economia e Finanza (Occasional Papers) 213, Bank of Italy, Economic Research and International Relations Area.
  3. Hale, Galina & Obstfeld, Maurice, 2014. "The euro and the geography of international debt flows," Working Paper Series 2014-10, Federal Reserve Bank of San Francisco.
  4. Camille Cornand & Pauline Gandré & Céline Gimet, 2014. "Increase in Home Bias and the Eurozone Sovereign Debt Crisis," Working Papers halshs-01015475, HAL.
  5. 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.
  6. Uhlig, Harald, 2013. "Sovereign Default Risk and Banks in a Monetary Union," CEPR Discussion Papers 9606, C.E.P.R. Discussion Papers.
  7. Camille Cornand & Pauline Gandré & Céline Gimet, 2014. "Increase in Home Bias and the Eurozone Sovereign Debt Crisis," Working Papers 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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