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Dynamics of Investment, Debt, and Default

Author

Listed:
  • Grey Gordon

    (Indiana University)

  • Pablo Guerron-Quintana

    (Boston College)

Abstract

This paper proposes a sovereign default model with long-term debt and endogenous output and investment that simultaneously accounts for default episodes and business cycles in emerging economies. In response to positive productivity shocks, risk premia fall and the sovereign borrows to finance investment. When adverse productivity shocks make international borrowing expensive, the sovereign responds by rolling over debt and reducing investment. This causes output to fall and the debt-output ratio to increase, and default occurs if the negative shocks continue long enough. Consequently, the model generates first an increase and then a decrease in investment, consumption, and output prior to default, as in the data. These relationships between productivity, spreads, investment, and borrowing also make the model consistent with many features of small open economy business cycles such as countercyclical spreads and net exports. While capital has non-trivial effects on the incentive to default, increased capital almost always reduces risk premia in equilibrium. (Copyright: Elsevier)

Suggested Citation

  • Grey Gordon & Pablo Guerron-Quintana, 2018. "Dynamics of Investment, Debt, and Default," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 28, pages 71-95, April.
  • Handle: RePEc:red:issued:14-216
    DOI: 10.1016/j.red.2017.07.007
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    Cited by:

    1. Marios Karabarbounis & Patrick Macnamara, 2019. "Misallocation and Credit Market Constraints: the Role of Long-Term Financing," Working Paper 19-1, Federal Reserve Bank of Richmond.
    2. Arellano, Cristina & Bai, Yan & Mihalache, Gabriel, 2018. "Default risk, sectoral reallocation, and persistent recessions," Journal of International Economics, Elsevier, vol. 112(C), pages 182-199.
    3. Yongquan Cao & Grey Gordon, 2019. "A Practical Approach to Testing Calibration Strategies," Computational Economics, Springer;Society for Computational Economics, vol. 53(3), pages 1165-1182, March.
    4. Park, JungJae, 2011. "Sovereign Default and Capital Accumulation," MPRA Paper 60150, University Library of Munich, Germany, revised Nov 2014.
    5. Aguiar, M. & Chatterjee, S. & Cole, H. & Stangebye, Z., 2016. "Quantitative Models of Sovereign Debt Crises," Handbook of Macroeconomics, in: J. B. Taylor & Harald Uhlig (ed.), Handbook of Macroeconomics, edition 1, volume 2, chapter 0, pages 1697-1755, Elsevier.
    6. Dominik Thaler, 2021. "Sovereign Default, Domestic Banks and Exclusion from International Capital Markets," Economic Journal, Royal Economic Society, vol. 131(635), pages 1401-1427.
    7. Siming Liu & Hewei Shen, . "Fiscal Commitment and Sovereign Default Risk," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics.
    8. Park, JungJae, 2017. "Sovereign default and capital accumulation," Journal of International Economics, Elsevier, vol. 106(C), pages 119-133.
    9. Galli, Carlo, 2021. "Self-fulfilling debt crises, fiscal policy and investment," Journal of International Economics, Elsevier, vol. 131(C).
    10. Tamon Asonuma & Marcos Chamon & Aitor Erce & Akira Sasahara, 2019. "Costs of sovereign defaults: Restructuring strategies, bank distress and the capital inflow-credit channel," Working Papers 37, European Stability Mechanism.
    11. Mihalache, Gabriel, 2020. "Sovereign default resolution through maturity extension," Journal of International Economics, Elsevier, vol. 125(C).
    12. Grey Gordon & Pablo Guerron-Quintana, 2018. "Dynamics of Investment, Debt, and Default," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 28, pages 71-95, April.
    13. Tavares, Tiago, 2019. "Labor market distortions under sovereign debt default crises," Journal of Economic Dynamics and Control, Elsevier, vol. 108(C).
    14. Tamon Asonuma & Hyungseok Joo, 2021. "Public Capital and Fiscal Constraint in Sovereign Debt Crises," School of Economics Discussion Papers 0621, School of Economics, University of Surrey.
    15. Phan, Toan, 2017. "A model of sovereign debt with private information," Journal of Economic Dynamics and Control, Elsevier, vol. 83(C), pages 1-17.
    16. Yang, Zhenbing & Chen, Zhuo & Shi, Qi & Yan, Bing, 2021. "Does outward foreign direct investment increase debt ratio? Firm-level evidence from China," Structural Change and Economic Dynamics, Elsevier, vol. 57(C), pages 1-12.
    17. Ram Yamarthy, 2019. "Corporate Debt Maturity and the Real Economy," 2019 Meeting Papers 627, Society for Economic Dynamics.
    18. Guerron-Quintana, Pablo A., 2020. "“Migration and sovereign default risk” a comment," Journal of Monetary Economics, Elsevier, vol. 113(C), pages 23-27.
    19. Kollintzas, Tryphon & Tsoukalas, Konstantinos, 2015. "Bank and Sovereign Risk Interdependence in the Euro Area," CEPR Discussion Papers 10485, C.E.P.R. Discussion Papers.
    20. Grey Gordon & Pablo Guerron-Quintana, 2019. "A Quantitative Theory of Hard and Soft Sovereign Defaults," 2019 Meeting Papers 412, Society for Economic Dynamics.
    21. Cusato Novelli, Antonio & Barcia, Giancarlo, 2021. "Sovereign Risk, Public Investment and the Fiscal Policy Stance," Journal of Macroeconomics, Elsevier, vol. 67(C).
    22. Alessandria, George & Bai, Yan & Deng, Minjie, 2020. "Migration and sovereign default risk," Journal of Monetary Economics, Elsevier, vol. 113(C), pages 1-22.

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    More about this item

    Keywords

    Investment; Debt; Default; Long-term debt;
    All these keywords.

    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F44 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Business Cycles

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