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Sovereign Debt Sustainability with Involuntary Default

Author

Listed:
  • Fabrice Collard

    (TSE-R - Toulouse School of Economics - UT Capitole - Université Toulouse Capitole - UT - Université de Toulouse - EHESS - École des hautes études en sciences sociales - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement)

  • Michel Habib

    (UZH - Universität Zürich [Zürich] = University of Zurich)

  • Ugo Panizza

    (Graduate Institute Geneva)

  • Jean-Charles Rochet

    (TSE-R - Toulouse School of Economics - UT Capitole - Université Toulouse Capitole - UT - Université de Toulouse - EHESS - École des hautes études en sciences sociales - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement)

Abstract

We study the sustainability of sovereign debt under the assumption of involuntary and costly default: governments do their utmost to avoid default, which reduces the resources available for debt service. We show that costly default tightens Blanchard's g > r condition. We derive a formula for a government's maximum sustainable debt (MSD), which depends on the mean and the volatility of the country's growth rate, the government's maximum primary surplus, the risk-free rate, and the fraction of resources available to the government in default. We compute MSD for 12 Eurozone countries and examine the role of the European Stability Mechanism in increasing MSD.

Suggested Citation

  • Fabrice Collard & Michel Habib & Ugo Panizza & Jean-Charles Rochet, 2024. "Sovereign Debt Sustainability with Involuntary Default," Working Papers hal-04822341, HAL.
    • Handle: RePEc:hal:wpaper:hal-04822341
    Note: View the original document on HAL open archive server: https://hal.science/hal-04822341v1
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    References listed on IDEAS

    as
    1. Patrick Bolton & Olivier Jeanne, 2011. "Sovereign Default Risk and Bank Fragility in Financially Integrated Economies," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 59(2), pages 162-194, June.
    2. Atish R. Ghosh & Jun I. Kim & Enrique G. Mendoza & Jonathan D. Ostry & Mahvash S. Qureshi, 2013. "Fiscal Fatigue, Fiscal Space and Debt Sustainability in Advanced Economies," Economic Journal, Royal Economic Society, vol. 0, pages 4-30, February.
    3. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
    4. Barry Eichengreen & Ugo Panizza, 2016. "A surplus of ambition: can Europe rely on large primary surpluses to solve its debt problem?," Economic Policy, CEPR, CESifo, Sciences Po;CES;MSH, vol. 31(85), pages 5-49.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Sovereign Debt; Default; Maximum Sustainable Debt;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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