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Sovereign debt markets in turbulent times: creditor discrimination and crowding-out effects

  • Fernando Broner

    (CREI, Universitat Pompeu Fabra and Barcelona GSE)

  • Alberto Martin

    (CREI, Universitat Pompeu Fabra and Barcelona GSE)

  • Jaume Ventura

    (CREI, Universitat Pompeu Fabra and Barcelona GSE)

  • Aitor Erce

    (Banco de España and European stability mechanism)

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 recession, 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 sector, reducing investment and deepening the recession 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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File URL: http://www.bde.es/f/webbde/SES/Secciones/Publicaciones/PublicacionesSeriadas/DocumentosTrabajo/14/Fich/dt1402e.pdf
File Function: First version, February 2014
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Paper provided by Banco de Espa�a in its series Banco de Espa�a Working Papers with number 1402.

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Length: 69 pages
Date of creation: Feb 2014
Date of revision:
Handle: RePEc:bde:wpaper:1402
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  1. Broner, Fernando A & Didier, Tatiana & Erce, Aitor & Schmukler, Sergio, 2011. "Gross Capital Flows: Dynamics and Crises," CEPR Discussion Papers 8591, C.E.P.R. Discussion Papers.
  2. Bolton, Patrick & Jeanne, Olivier, 2011. "Sovereign Default Risk and Bank Fragility in Financially Integrated Economies," CEPR Discussion Papers 8358, C.E.P.R. Discussion Papers.
  3. Fernando A Broner & Alberto Martin & Jaume Ventura, 2006. "Sovereign Risk and Secondary Markets," Working Papers 306, Barcelona Graduate School of Economics.
  4. Guido Lorenzoni & Ivan Werning, 2014. "Slow Moving Debt Crises," Levine's Working Paper Archive 786969000000000939, David K. Levine.
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  9. Brutti, Filippo, 2011. "Sovereign defaults and liquidity crises," Journal of International Economics, Elsevier, vol. 84(1), pages 65-72, May.
  10. Fernando A Broner & Jaume Ventura, 2006. "Globalization and Risk Sharing," Working Papers 307, Barcelona Graduate School of Economics.
  11. Fernando Broner & Jaume Ventura, 2010. "Rethinking the effects of financial liberalization," Economics Working Papers 1128, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 2013.
  12. Juan J. Cruces & Christoph Trebesch, 2013. "Sovereign Defaults: The Price of Haircuts," American Economic Journal: Macroeconomics, American Economic Association, vol. 5(3), pages 85-117, July.
  13. Vivian Z. Yue & Enrique G. Mendoza, 2011. "A General Equilibrium Model of Sovereign Default and Business Cycles," IMF Working Papers 11/166, International Monetary Fund.
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  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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  18. Juan Carlos Conesa & Timothy J. Kehoe, 2012. "Gambling for redemption and self-fulfilling debt crises," Staff Report 465, Federal Reserve Bank of Minneapolis.
  19. Cole, Harold L & Kehoe, Timothy J, 2000. "Self-Fulfilling Debt Crises," Review of Economic Studies, Wiley Blackwell, vol. 67(1), pages 91-116, January.
  20. Mengus, E., 2014. "Honoring Sovereign Debt or Bailing Out Domestic Residents: A Theory of Internal Costs of Default," Working papers 480, Banque de France.
  21. Lanau, Sergi, 2011. "The contractual approach to sovereign debt restructuring," Bank of England working papers 409, Bank of England.
  22. Serkan Arslanalp & Takahiro Tsuda, 2012. "Tracking Global Demand for Advanced Economy Sovereign Debt," IMF Working Papers 12/284, International Monetary Fund.
  23. Oren Sussman & Alexander Guembel, 2005. "Sovereign Debt Without Default Penalties," OFRC Working Papers Series 2005fe17, Oxford Financial Research Centre.
  24. Jochen R. Andritzky, 2012. "Government Bonds and their Investors; What Are the Facts and Do they Matter?," IMF Working Papers 12/158, International Monetary Fund.
  25. 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.
  26. Alexander Guembel & Oren Sussman, 2009. "Sovereign Debt without Default Penalties," Review of Economic Studies, Oxford University Press, vol. 76(4), pages 1297-1320.
  27. Silvia Merler & Jean Pisani-Ferry, 2012. "Who's afraid of sovereign bonds?," Policy Contributions 695, Bruegel.
  28. Silvia Ardagna & Francesco Caselli, 2012. "The Political Economy of the Greek Debt Crisis: A Tale of Two Bailouts," CEP Special Papers 25, Centre for Economic Performance, LSE.
  29. Aitor Erce, 2012. "Selective sovereign defaults," Globalization and Monetary Policy Institute Working Paper 127, Federal Reserve Bank of Dallas.
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