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A General Equilibrium Model of Sovereign Default and Business Cycles

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  • Zhanwei Z. Yue
  • Enrique G. Mendoza

Abstract

Emerging markets business cycle models treat default risk as part of an exogenous interest rate on working capital, while sovereign default models treat income fluctuations as an exogenous endowment process with ad-noc default costs. We propose instead a general equilibrium model of both sovereign default and business cycles. In the model, some imported inputs require working capital financing; default on public and private obligations occurs simultaneously. The model explains several features of cyclical dynamics around default triggers an efficiency loss as these inputs are replaced by imperfect substitutes; and default on public and private obligations occurs simultaneously. The model explains several features of cyclical dynamics around deraults, countercyclical spreads, high debt ratios, and key business cycle moments.

Suggested Citation

  • Zhanwei Z. Yue & Enrique G. Mendoza, 2011. "A General Equilibrium Model of Sovereign Default and Business Cycles," IMF Working Papers 2011/166, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:2011/166
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    More about this item

    Keywords

    Labor; Total factor productivity; Labor supply; Debt default; Public debt; WP; debt ratio; working capital;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems

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