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

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Author Info

  • Fernando Broner
  • Aitor Erce
  • Alberto Martin
  • 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 International Monetary Fund in its series IMF Working Papers with number 13/270.

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Length: 63
Date of creation: 27 Dec 2013
Date of revision:
Handle: RePEc:imf:imfwpa:13/270

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Keywords: Sovereign debt; Europe; Spillovers; Financial crisis; Bond issues; Investment; Economic models; rollover crises; secondary markets; economic growth; domestic creditors; domestic debt; debt crises; public debt; debt crisis; debt maturity; stock of debt; debt problems; private credit; sovereign defaults; central banks; government debt; debt dynamics; sovereign debt crises; short-term debt; sovereign debt crisis; debt holders; amount of debt; foreign debt; sovereign debts; external borrowing; public debts; debt renegotiation; debt data; private creditors; liquidity crises; debt accumulation; repurchases; sovereign bonds; bilateral agreements; low debts; debt stocks; debt restructuring; reserve bank; public borrowing; long-term debt; domestic borrowing; current account adjustments; debt burden; official creditors; debt overhang; international lending; sovereign debt renegotiation;

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References

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  1. Mark Aguiar & Manuel Amador & Gita Gopinath, 2007. "Investment Cycles and Sovereign Debt Overhang," NBER Working Papers 13353, National Bureau of Economic Research, Inc.
  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.
  3. Timothy Kehoe & Juan Carlos Conesa, 2012. "Gambling for Redemption and Self-Fulfilling Debt Crises," 2012 Meeting Papers 614, Society for Economic Dynamics.
  4. Broner, Fernando A & Ventura, Jaume, 2006. "Globalization and Risk Sharing," CEPR Discussion Papers 5820, C.E.P.R. Discussion Papers.
  5. Lanau, Sergi, 2011. "The contractual approach to sovereign debt restructuring," Bank of England working papers 409, Bank of England.
  6. Oren Sussman & Alexander Guembel, 2005. "Sovereign Debt Without Default Penalties," OFRC Working Papers Series 2005fe17, Oxford Financial Research Centre.
  7. Harold L. Cole & Timothy J. Kehoe, 1998. "Self-fulfilling debt crises," Staff Report 211, Federal Reserve Bank of Minneapolis.
  8. Mark Aguiar & Manuel Amador, 2010. "Growth in the Shadow of Expropriation," 2010 Meeting Papers 1194, Society for Economic Dynamics.
  9. Silvia Merler & Jean Pisani-Ferry, 2012. "Who's afraid of sovereign bonds?," Policy Contributions 695, Bruegel.
  10. Bai, Yan & Zhang, Jing, 2012. "Duration of sovereign debt renegotiation," Journal of International Economics, Elsevier, vol. 86(2), pages 252-268.
  11. Brutti, Filippo, 2011. "Sovereign defaults and liquidity crises," Journal of International Economics, Elsevier, vol. 84(1), pages 65-72, May.
  12. Aitor Erce, 2012. "Selective sovereign defaults," Globalization and Monetary Policy Institute Working Paper 127, Federal Reserve Bank of Dallas.
  13. Jochen R. Andritzky, 2012. "Government Bonds and their Investors," IMF Working Papers 12/158, International Monetary Fund.
  14. Calvo, Guillermo A, 1988. "Servicing the Public Debt: The Role of Expectations," American Economic Review, American Economic Association, vol. 78(4), pages 647-61, September.
  15. Philip R. Lane, 2012. "The European Sovereign Debt Crisis," Journal of Economic Perspectives, American Economic Association, vol. 26(3), pages 49-68, Summer.
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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.

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