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Domestic Debt and Sovereign Defaults

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Abstract

This paper examines how domestic holdings of government debt affect sovereign default risk and government debt management. I develop a dynamic stochastic general equilibrium model with both external and domestic debt that endogenously generates output contraction upon default. Domestic holdings of government debt weaken investors' balance sheets and induce a contraction of credit and output upon default. I calibrate the model to the Argentinean economy and show that the model reproduces key empirical moments. Introducing domestic debt also yields relevant normative implications. While domestic debt is crucial to determining the risk of default, the efficient internal-external composition of debt cannot be achieved without government intervention. Pigouvian subsidies can restore efficiency.

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  • Enrico Mallucci, 2015. "Domestic Debt and Sovereign Defaults," International Finance Discussion Papers 1153, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgif:1153
    DOI: 10.17016/IFDP.2015.1153
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    1. Domestic Debt and Sovereign Defaults
      by Christian Zimmermann in NEP-DGE blog on 2016-03-20 03:02:55

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    Cited by:

    1. Aitor Erce, 2012. "Selective sovereign defaults," Globalization Institute Working Papers 127, Federal Reserve Bank of Dallas.
    2. Sewon Hur & César Sosa-Padilla & Zeynep Yom, 2021. "Optimal Bailouts in Banking and Sovereign Crises," Globalization Institute Working Papers 406, Federal Reserve Bank of Dallas, revised 27 Feb 2024.
    3. Sosa-Padilla, César, 2018. "Sovereign defaults and banking crises," Journal of Monetary Economics, Elsevier, vol. 99(C), pages 88-105.
    4. Illenin Kondo & Fabrizio Perri & Sewon Hur, 2016. "Inflation, Debt, and Default," 2016 Meeting Papers 1610, Society for Economic Dynamics.
    5. Galli, Carlo, 2021. "Self-fulfilling debt crises, fiscal policy and investment," Journal of International Economics, Elsevier, vol. 131(C).
    6. 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.
    7. Sewon Hur & Illenin O. Kondo & Fabrizio Perri, 2018. "Real Interest Rates, Inflation, and Default," Staff Report 574, Federal Reserve Bank of Minneapolis.
    8. Frederik Eidam & Friedrich Heinemann, 2019. "Towards more feasible sovereign debt restructurings in the euro area," EconPol Policy Reports 12, ifo Institute - Leibniz Institute for Economic Research at the University of Munich.
    9. Flavia Corneli, 2024. "Sovereign debt maturity structure and its costs," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 31(1), pages 262-297, February.
    10. Cheng, Jiahui & Chang, Senfeng, 2025. "Rare disasters, local currency-denominated external debt and sovereign default risk," Economics Letters, Elsevier, vol. 250(C).
    11. Paczos, Wojtek & Shakhnov, Kirill, 2022. "Defaulting on Covid debt," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 77(C).
    12. Di Casola, Paola & Sichlimiris, Spyridon, 2017. "Domestic and External Sovereign Debt," Working Paper Series 345, Sveriges Riksbank (Central Bank of Sweden).
    13. Enrique Alberola-Ila & Carlos Cantú & Paolo Cavallino & Nikola Mirkov, 2021. "Fiscal regimes and the exchange rate," BIS Working Papers 950, Bank for International Settlements.
    14. Christoph March & Robert K. Weizsäcker, 2020. "Coordinating intergenerational redistribution and the repayment of public debt: an experimental test of Tabellini (1991)," Social Choice and Welfare, Springer;The Society for Social Choice and Welfare, vol. 55(2), pages 301-323, August.

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    Keywords

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    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
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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