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Internal Debt Crises and Sovereign Defaults

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Author Info
Cristina Arellano
Narayana R. Kocherlakota

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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 National Bureau of Economic Research, Inc in its series NBER Working Papers with number 13794.

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Date of creation: Feb 2008
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Handle: RePEc:nbr:nberwo:13794

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Find related papers by JEL classification:
F34 - International Economics - - International Finance - - - International Lending and Debt Problems
G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Martin Schneider & Aaron Tornell, 2000. "Balance SHeet Effects, Bailout Guarantees and Financial Crises," NBER Working Papers 8060, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  2. Enrique G. Mendoza & Vivian Z. Yue, 2008. "A Solution to the Default Risk-Business Cycle Disconnect," NBER Working Papers 13861, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  3. Marco Bassetto & Christopher Phelan, 2006. "Tax riots," Working Paper Series WP-06-04, Federal Reserve Bank of Chicago. [Downloadable!]
    Other versions:
  4. Hoyt Bleakley & Kevin Cowan, 2002. "Corporate dollar debt and depreciations: much ado about nothing?," Working Papers 02-5, Federal Reserve Bank of Boston. [Downloadable!]
    Other versions:
  5. repec:bep:macadv:v:1:y:2001:i:advances/1/1:p:1002-1002 is not listed on IDEAS
  6. Arellano, Cristina, 2008. "Default risk and income fluctuations in emerging economies," MPRA Paper 7867, University Library of Munich, Germany. [Downloadable!]
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  7. Michael Tomz & Mark L. J. Wright, 2007. "Do Countries Default in "Bad Times" ?," Journal of the European Economic Association, MIT Press, vol. 5(2-3), pages 352-360, 04-05. [Downloadable!] (restricted)
    Other versions:
  8. Carlsson, Hans & van Damme, Eric, 1993. "Global Games and Equilibrium Selection," Econometrica, Econometric Society, vol. 61(5), pages 989-1018, September. [Downloadable!] (restricted)
    Other versions:
  9. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Blackwell Publishing, vol. 51(3), pages 393-414, July. [Downloadable!] (restricted)
  10. V.V. Chari & Patrick J. Kehoe, 1999. "Asking the right questions about the IMF," Annual Report, Federal Reserve Bank of Minneapolis, pages 3-26.
  11. Caballero, Ricardo J. & Krishnamurthy, Arvind, 2001. "International and domestic collateral constraints in a model of emerging market crises," Journal of Monetary Economics, Elsevier, vol. 48(3), pages 513-548, December. [Downloadable!] (restricted)
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  12. A. Rampini, Adriano, 2005. "Default and aggregate income," Journal of Economic Theory, Elsevier, vol. 122(2), pages 225-253, June. [Downloadable!] (restricted)
  13. Narayana R. Kocherlakota & Ilhyock Shim, 2007. "Forbearance and Prompt Corrective Action," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(5), pages 1107-1129, 08. [Downloadable!] (restricted)
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  14. Stanley Fischer, 1999. "On the Need for an International Lender of Last Resort," Journal of Economic Perspectives, American Economic Association, vol. 13(4), pages 85-104, Fall. [Downloadable!] (restricted)
  15. Roberto Chang & Andres Velasco, 1998. "Financial Crises in Emerging Markets," NBER Working Papers 6606, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  16. 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. [Downloadable!] (restricted)
  17. Cole, Harold L & Kehoe, Timothy J, 2000. "Self-Fulfilling Debt Crises," Review of Economic Studies, Blackwell Publishing, vol. 67(1), pages 91-116, January.
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  18. Kaminsky, Graciela L. & Reinhart, Carmen M., 2000. "On crises, contagion, and confusion," Journal of International Economics, Elsevier, vol. 51(1), pages 145-168, June. [Downloadable!] (restricted)
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  19. Roberto Chang & Andrés Velasco, 2001. "A Model Of Financial Crises In Emerging Markets," The Quarterly Journal of Economics, MIT Press, vol. 116(2), pages 489-517, May. [Downloadable!] (restricted)
  20. Burnside, Craig & Eichenbaum, Martin & Rebelo, Sergio, 2004. "Government guarantees and self-fulfilling speculative attacks," Journal of Economic Theory, Elsevier, vol. 119(1), pages 31-63, November. [Downloadable!] (restricted)
Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Nicola Gennaioli & Alberto Martin & Stefano Rossi, 2009. "Institutions, Public Debt and Foreign Finance," Economics Working Papers 1170, Department of Economics and Business, Universitat Pompeu Fabra. [Downloadable!]
  2. Enrique G. Mandoza & Vivian Z. Yue, 2008. "A solution to the default risk-business cycle disconnect," International Finance Discussion Papers 924, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  3. Enrique G. Mendoza & Vivian Z. Yue, 2008. "A Solution to the Default Risk-Business Cycle Disconnect," NBER Working Papers 13861, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  4. Bertrand Gruss & Karel Mertens, 2009. "Regime Switching Interest Rates and Fluctuations in Emerging Markets," Economics Working Papers ECO2009/22, European University Institute. [Downloadable!]
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