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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 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 euro zone, and how they may be addressed by policies at the European level.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 19676.

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Date of creation: Nov 2013
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Publication status: published as Broner, Fernando & Erce, Aitor & Martin, Alberto & Ventura, Jaume, 2014. "Sovereign debt markets in turbulent times: Creditor discrimination and crowding-out effects," Journal of Monetary Economics, Elsevier, vol. 61(C), pages 114-142.
Handle: RePEc:nbr:nberwo:19676

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  1. Fernando A Broner & Jaume Ventura, 2006. "Globalization and Risk Sharing," Working Papers 307, Barcelona Graduate School of Economics.
  2. Guido Lorenzoni & Ivan Werning, 2014. "Slow Moving Debt Crises," Levine's Working Paper Archive 786969000000000939, David K. Levine.
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  4. Oren Sussman & Alexander Guembel, 2005. "Sovereign Debt Without Default Penalties," OFRC Working Papers Series, Oxford Financial Research Centre 2005fe17, Oxford Financial Research Centre.
  5. 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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  8. Bolton, Patrick & Jeanne, Olivier, 2011. "Sovereign Default Risk and Bank Fragility in Financially Integrated Economies," CEPR Discussion Papers, C.E.P.R. Discussion Papers 8358, C.E.P.R. Discussion Papers.
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  23. 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. Harald Uhlig, 2013. "Sovereign Default Risk and Banks in a Monetary Union," NBER Working Papers 19343, National Bureau of Economic Research, Inc.
  2. Camille Cornand & Pauline Gandré & Céline Gimet, 2014. "Increase in Home Bias and the Eurozone Sovereign Debt Crisis," Working Papers halshs-01015475, HAL.
  3. Serkan Arslanalp & Takahiro Tsuda, 2014. "Tracking Global Demand for Emerging Market Sovereign Debt," IMF Working Papers 14/39, International Monetary Fund.
  4. 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.
  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. 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.
  7. 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.
  8. Galina Hale & Maurice Obstfeld, 2014. "The Euro and The Geography of International Debt Flows," NBER Working Papers 20033, National Bureau of Economic Research, Inc.
  9. 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.
  10. 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.

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