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Internal Debt Crises and Sovereign Defaults

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  • Cristina Arellano
  • Narayana Kocherlakota

Abstract

In this paper, we use data from developing countries to argue that sovereign defaults are often caused by fiscal pressures generated by large-scale domestic defaults. We argue that these systemic domestic defaults are caused by shocks best interpreted as being non-fundamental. We construct a model that is consistent with these observations. The key ingredient of the model is that it is impossible to liquidate large amounts of entrepreneurial assets. This restriction generates the possibility of a domestic coordinated default crisis, in which domestic borrowers find it optimal to default because all other borrowers are also defaulting. We conclude that avoiding sovereign defaults requires better internal institutions, not better external ones.

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Paper provided by UCLA Department of Economics in its series Levine's Bibliography with number 122247000000001880.

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Date of creation: 10 Feb 2008
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Handle: RePEc:cla:levrem:122247000000001880

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  1. Ilhyock Shim & Narayana Kocherlakota, 2005. "Forbearance and prompt corrective action," BIS Working Papers 177, Bank for International Settlements.
  2. Michael Tomz & Mark L. J. Wright, 2007. "Do Countries Default in "Bad Times" ?," Journal of the European Economic Association, MIT Press, MIT Press, vol. 5(2-3), pages 352-360, 04-05.
  3. Carmen M. Reinhart & Kenneth S. Rogoff, 2008. "This Time is Different: A Panoramic View of Eight Centuries of Financial Crises," CEMA Working Papers, China Economics and Management Academy, Central University of Finance and Economics 595, China Economics and Management Academy, Central University of Finance and Economics.
  4. Enrique G. Mendoza & Vivian Z. Yue, 2008. "A Solution to the Disconnect between Country Risk and Business Cycle Theories," NBER Working Papers 13861, National Bureau of Economic Research, Inc.
  5. Harold L. Cole & Timothy J. Kehoe, 1998. "Self-Fulfilling Debt Crises," Levine's Working Paper Archive 114, David K. Levine.
  6. Kocherlakota Narayana R, 2001. "Risky Collateral and Deposit Insurance," The B.E. Journal of Macroeconomics, De Gruyter, De Gruyter, vol. 1(1), pages 1-20, February.
  7. Carmen M. Reinhart & Kenneth S. Rogoff, 2011. "From Financial Crash to Debt Crisis," American Economic Review, American Economic Association, American Economic Association, vol. 101(5), pages 1676-1706, August.
  8. Hoyt Bleakley & Kevin Cowan, 2002. "Corporate dollar debt and depreciations: much ado about nothing?," Working Papers, Federal Reserve Bank of Boston 02-5, Federal Reserve Bank of Boston.
  9. Martin Schneider & Aaron Tornell, 2004. "Balance Sheet Effects, Bailout Guarantees and Financial Crises," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 71, pages 883-913, 07.
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  11. Hans Carlsson & Eric van Damme, 1993. "Global Games and Equilibrium Selection," Levine's Working Paper Archive 122247000000001088, David K. Levine.
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  13. Cristina Arellano, 2008. "Default Risk and Income Fluctuations in Emerging Economies," American Economic Review, American Economic Association, American Economic Association, vol. 98(3), pages 690-712, June.
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  16. Gerard Caprio, Jr. and Patrick Honohan, 2008. "Banking Crises," The Institute for International Integration Studies Discussion Paper Series, IIIS iiisdp242, IIIS.
  17. Burnside, Craig & Eichenbaum, Martin & Rebelo, Sergio, 2004. "Government guarantees and self-fulfilling speculative attacks," Journal of Economic Theory, Elsevier, Elsevier, vol. 119(1), pages 31-63, November.
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  19. Roberto Chang & Andres Velasco, 1998. "Financial Crises in Emerging Markets," NBER Working Papers 6606, National Bureau of Economic Research, Inc.
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Cited by:
  1. Carmen M. Reinhart & Kenneth S. Rogoff, 2008. "The Forgotten History of Domestic Debt," NBER Working Papers 13946, National Bureau of Economic Research, Inc.
  2. Gennaioli, Nicola & Martin, Alberto & Rossi, Stefano, 2010. "Sovereign Default, Domestic Banks and Financial Institutions," CEPR Discussion Papers, C.E.P.R. Discussion Papers 7955, C.E.P.R. Discussion Papers.
  3. Wang, Alan T. & Yang, Sheng-Yung & Yang, Nien-Tzu, 2013. "Information transmission between sovereign debt CDS and other financial factors – The case of Latin America," The North American Journal of Economics and Finance, Elsevier, Elsevier, vol. 26(C), pages 586-601.
  4. Vivian Z. Yue & Enrique G. Mendoza, 2011. "A General Equilibrium Model of Sovereign Default and Business Cycles," IMF Working Papers 11/166, International Monetary Fund.
  5. Enrique G. Mandoza & Vivian Z. Yue, 2008. "A solution to the default risk-business cycle disconnect," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 924, Board of Governors of the Federal Reserve System (U.S.).
  6. Satyajit Chatterjee & Burcu Eyigungor, 2011. "A quantitative analysis of the U.S. housing and mortgage markets and the foreclosure crisis," Working Papers 11-26, Federal Reserve Bank of Philadelphia.
  7. Bertrand Gruss & Karel Mertens, 2009. "Regime Switching Interest Rates and Fluctuations in Emerging Markets," Economics Working Papers, European University Institute ECO2009/22, European University Institute.
  8. Aitor Erce, 2012. "Selective sovereign defaults," Globalization and Monetary Policy Institute Working Paper, Federal Reserve Bank of Dallas 127, Federal Reserve Bank of Dallas.
  9. Aitor Erce Domiguez, 2010. "Debtor Discrimination During Sovereign Debt Restructurings," 2010 Meeting Papers, Society for Economic Dynamics 1324, Society for Economic Dynamics.
  10. Enrique G. Mendoza & Vivian Z. Yue, 2008. "A Solution to the Disconnect between Country Risk and Business Cycle Theories," NBER Working Papers 13861, National Bureau of Economic Research, Inc.
  11. Ureche-Rangau, Loredana & Burietz, Aurore, 2013. "One crisis, two crises…the subprime crisis and the European sovereign debt problems," Economic Modelling, Elsevier, Elsevier, vol. 35(C), pages 35-44.

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