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Financial Disruption as a Cost of Sovereign Default: a quantative assessment

Author

Listed:
  • Andre Diniz

    (Escola de Economia de São Paulo (EESP) Fundação Getulio Vargas)

  • Bernardo Guimaraes

    (Escola de Economia de São Paulo (EESP) Fundação Getulio Vargas)

Abstract

The recent European debt crisis has sparked a heated debate on the merits of fiscal austerity. Since the main objective of the proposed fiscal tightenings is to reduce sovereign default risk, the solution to this debate depends on the costs of a sovereign debt restructuring. One important cost is its negative effect on the banking system. This paper extends an off-the-shelf macroeconomic model with financial frictions in order to quantitatively assess the costs of financial disruption ensuing from a sovereign debt restructuring. Results show that the losses from financial disruption are offset by the benefits of a less contractionary fiscal policy. Government size is crucial for the relative effects of financial disruption as austerity becomes substantially more costly when tax rates are large.

Suggested Citation

  • Andre Diniz & Bernardo Guimaraes, 2014. "Financial Disruption as a Cost of Sovereign Default: a quantative assessment," Discussion Papers 1427, Centre for Macroeconomics (CFM).
  • Handle: RePEc:cfm:wpaper:1427
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    File URL: http://www.centreformacroeconomics.ac.uk/Discussion-Papers/2014/CFMDP2014-27-Paper.pdf
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    References listed on IDEAS

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    Cited by:

    1. Auray, Stéphane & Eyquem, Aurélien & Ma, Xiaofei, 2018. "Banks, sovereign risk and unconventional monetary policies," European Economic Review, Elsevier, vol. 108(C), pages 153-171.

    More about this item

    Keywords

    Financial Disruption; Sovereign Debt; Sovereign Default; Deleveraging;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • G01 - Financial Economics - - General - - - Financial Crises
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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