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Corporate-Sovereign Debt Nexus and Externalities

Author

Listed:
  • Jun Hee Kwak

    (Department of Economics, Sogang University, Seoul, Korea)

Abstract

I build a dynamic quantitative model in which both firms and the government can default. Rising endogenous corporate debt increases sovereign default risk, as tax revenues are expected to decrease. Externalities arise because it can be privately optimal but socially suboptimal for firms to default given their limited liability, rationalizing macroprudential interventions in corporate debt markets. I propose a set of such optimal policies that reduce the number of defaulting firms, increase fiscal space, and boost household consumption during financial crises. Contrary to conventional wisdom, countercyclical debt policy can be counterproductive, as the countercyclical policy induces more firmdefaults.

Suggested Citation

  • Jun Hee Kwak, 2023. "Corporate-Sovereign Debt Nexus and Externalities," Working Papers 2306, Nam Duck-Woo Economic Research Institute, Sogang University (Former Research Institute for Market Economy).
    • Handle: RePEc:sgo:wpaper:2306
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    File URL: https://zrr.kr/5Ds6
    File Function: First version, 2023
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    More about this item

    Keywords

    Sovereign Debt; Corporate Debt; Default; Macroprudential Policy; Externalities;
    All these keywords.

    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F38 - International Economics - - International Finance - - - International Financial Policy: Financial Transactions Tax; Capital Controls
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination

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